Want to know more about Deep Value Investing? Here are the five top tips you need to know before you jump in!
Warren Buffett is one of the best Deep Value investors of all time. In the 24 years between 1980 and 2003, Warren Buffett’s investment strategy has beaten the S&P 500 Index in 20 of those 24 years. He’s done this by using Value Investing, a philosophy he learned while a student of Benjamin Graham. In his strategy he looks for companies whose share price is trading below their intrinsic value and buys them. He looks for a simple-to-understand business with good management, high profit margins, and low debt -and then he holds their stock for a long period of time.
Basically, Deep Value Investing is investing in companies that have a low stock price in relation to their intrinsic value. Undervalued stocks give you a larger margin of safety when it comes to the market. They don’t have as far to fall, and have a bigger upside. There are various formulas used to screen for Deep Value stocks, including Benjamin Graham’s Net Current Asset Value per Share, Joel Greenblat’s Magic Formula, and Tobias Carlisle’s Acquirer’s Multiple.
Deep Value Investing focuses on finding under-valued stocks, i.e. stocks where the price has been driven down. This lowers the risks and increases the returns. Net Current Asset Value (NCAV) is calculated by taking Current Assets - Total Liabilities - Preferred Stock.
Basically, it’s the net worth of a company.
The Net Current Asset Value per Share (NCAVPS) is a measure created by Benjamin Graham and expresses what the company would be worth (per share) if all of its assets were sold off and all its liabilities paid off - divided by the number of outstanding shares. Graham considered preferred stock to be a liability so any preferred stock is subtracted as well. In some cases the stock price can be lower than the NCAVPS.
Graham believed that you would benefit by investing in companies where the stock prices was no more then 67% of the NCAVPS. In fact a study at the State University of New York showed that between 1970 and 1983 that an investor using this strategy and holding the stock for one year could have earned an average return of 29.4%
There is a reason these companies are under priced. Typically the company is going through a rough patch, revenues have dropped, they might’ve lost a large order or contract, or perhaps are subject to government fines. Or perhaps Management could be doing a poor job of running the company.
In the end the company has fallen out of favor with the market and it’s price is hurting because of it. But you need to be careful, there’s a big difference between a good company in a rough patch and a bad company headed down the toilet.
Look out for Management whose interests are not aligned with minority shareholders and check to see if they are extracting cash from the business for themselves or if there’s any possibility of fraud.
Nothing can sink a company faster than debt. High debt repayments can turn a profitable company into an unprofitable one, and an unprofitable company into a bankrupt one. Avoid the stock of any companies burning through their cash to make debt repayments.
Debt is included in the various formulas used to calculate value, like the Acquirer’s Multiple by Tobias Carlisle or the Magic Formula by Joel Greenblat. More debt = more risk.
You need to make sure you are diversified. There are tons of opinions on how to be truly diversified, like how many stocks you should own, what sectors, stocks vs bonds vs commodities vs real estate. In the end it comes down to what you are comfortable with. Regardless - make sure you are diversified by your own standard.
There is a reason most people don’t/can’t/won’t do Deep Value Investing – it takes patience. It can take several years for these companies to turn around, but when they do, watch out.
There’ll also be some years where your investment will go down. Most people freak out and get out before their Deep Value picks have a chance to turn around and make them money. It’s human nature.
Do you have the will power, grit, and determination to make it work? I hope I do.