Short selling is a risky business. Betting against a stock involves borrowing it from the market and selling it right away, waiting for the price to drop in the future. However, if the price remains stable or appreciates, the short seller could be on the hook for a large amount to cover the position.
Meanwhile, if the stock pays a steady and hefty dividend, the payout adds to the short seller’s losses. This is why professional sellers avoid dividend-paying stocks with a track record of outperformance. One such stock is private equity firm 3i Group (LSE: III).
3i’s stock price has tripled over the past five years and nearly sextupled over the past seven. Over the past half-decade, the company has also managed to maintain an average dividend yield of 3.9%. With dividends reinvested, the total return since 2014 has been 240% – absolutely horrifying for any short seller.
The investment firm has a robust and diversified portfolio split between mid-sized businesses in Europe, Asia and the Americas, and infrastructure projects in the United Kingdom, Europe and North America.
According to the corporate website: “Identifying new opportunities in which to invest proprietary capital is the primary driver of the Group’s ability to deliver attractive returns.” Last year, it deployed £827 million in fresh investments, a record high. Meanwhile, cash realisations were £1.27 billion over the same period, adding to the company’s war chest.
However, the most important performance metric for any private equity firm is the gross returns on investment. Last year, 3i delivered a 27% return on investment. The average over the past five years has been 28%. That’s even more impressive when you consider the fact that the company has had to grapple with the fallout of Brexit and the depreciating pound over that period.
I believe a combination of these factors make 3i a robust long-term investment opportunity. There’s no doubt that 3i is an excellent investment firm with a proven track record and an attractive dividend. However, I need to take a step further and figure out if the current stock price is in line with the company’s intrinsic value.
Fortunately, 3i reports its net asset value (NAV) every quarter. For the year to 31st March 2019, the company reported NAV per share of 815 pence. That’s 12.6% higher than the previous year, but 27% lower than the market price per share. In other words, the company seems fairly valued at its current price.
Bottom line
Warren Buffett often says that it’s better to pay a fair price for an excellent company than a great price for a mediocre one. After taking a closer look at the underlying portfolio, net asset value, dividend yield, and management reputation, I’m convinced that 3i is far from mediocre.
In fact, it’s one of my favourite FTSE 100 stocks at the moment. The fact that it’s currently trading at fair value makes it even more attractive.