In terms of portfolio organization, deep-value stocks are usually small-caps and I try not to go over 10 stocks (deep value or not).
I get my ideas from numerous places. It can range from a friend, articles posted online or certain investing sites, and sometimes certain screeners. Often, I like to look at SEC filings, Joel Greenblatt (Trades, Portfolio)'s Magic Formula and the 52- week lows.
3. What drew you to that specific strategy? If you only had three valuation metrics, what would they be?
The themes that drove me to this specific strategy are margin of safety and protection against permanent loss of capital. Those are my core concerns in any stock. Compound interest paired with good deep-value stocks, along with some time, will take care of the performance side. Of course, one should always be wary of value traps and miscalculations. Another reason that I like this strategy is that most of these stocks are under the radar- not popular nor researched as much in comparison to hot stocks, therefore I do not have to try to outsmart the next analyst or any of that sort.
I do not put much emphasis on a single valuation metric, or even a few. Because valuations are subjective and financial models and forecasts are more of an opinion rather than a prediction or a prophecy, valuation is more of an art than an exact science. Therefore, every investment case has its own unique merit. In playing piano, you cannot play a masterpiece with a single note, you need the keys to flow together in order to project your art. Similarly, it is difficult to tell the story of a company with just a few valuation metrics, they all have to be included and analyzed together for a more "logical" valuation.
But, if gun to my head, and hesitantly, I had to choose only three valuation metrics, I would look for a good NCAV (Net Current Assets - Total Liabilities to be significantly positive), low price-earnings (as these stocks tend to perform well over the long run), EV/ EBITDA and, to add another one, price-book. In isolation, each metric has their own merit but also a significant blindspot.
4. What books or other investors changed the way you think, inspired you or mentored you? What is the most important lesson learned from them? What investors do you follow today?
I spend a lot of time reading, particularly business and investment books. Every single book has, in one extent or another, influenced me. I try to absorb the most useful concepts from these books and borrow ideas from various greats and mix them in a box with a little bias towards deep-value investing.
You can check out my full booklist here.
My very first investment book was "The Neatest Little Guide to Stock Market Investing" by Jason Kelly, which shed the very first investing light upon me. "The Intelligent Investor" by Benjamin Graham definetly made the biggest impression on me. "Security Analysis" by Graham and Dodd, "A Random Walk Down Wall Street" by Burton G. Malkiel, "The Most Important Thing Illuminated" by Howard Marks (Trades, Portfolio) and "Margin of Safety" by Seth Klarman (Trades, Portfolio) have all helped reinforce the concept of margin of safety and protection against permanent loss of capital.
Other great investors that have inspired me and that are worth researching are Joel Greenblatt (Trades, Portfolio), Peter Cundill, George Soros (Trades, Portfolio), Philip A. Fisher, Peter Lynch and Mohnish Pabrai (the list goes on).
If I had to single out an important lesson, it is that much of the investing knowledge can be learned for most individuals, the difficult part is controlling your emotions. As, Graham, the father of value investing himself, puts it:
"The fault dear investors is not in our stars- and not in our stocks- but in ourselves".
Today, I follow top value investors, particularly Buffett, Klarman and Greenblatt.
5. How long will you hold a stock and why? How long does it take to know if you are right or wrong on a stock?
I invest for the long run, but I would not put a specific time horizon on holdings (especially with deep-value stocks). I would say that deep-value stocks and undervalued stocks in general tend to eventually converge towards their "intrinsic value" after some time, so I hold them until then and re-evaluate, or until the margin of safety has been erased.
Additionally, if there is a threat for permanent capital loss, or if I was just wrong in my decision making, I will sell the stock. I change when the facts and fundamentals change. Typically, I would want to hold a stock forever, assuming it retains and can grow its intrinsic value in relationship to price. The dilemma some investors face is that often times, it may take a while for the market to correctly price an undervalued stock; this is why margin of safety is so important.
6. How has your investing approach changed over the years?
My investment approach has evolved dramatically since I began my investing journey. I started more as a technical investor, holding active options. Early on, I had a strong reliance on technical metrics such as RSI, moving averages, volume and other technical indicators. Through personal growth, reading and acquiring greater knowledge, I transitioned to value and deep-value investing. Initially, I would use broader metrics and rely on quality companies with fair prices. Now, I lean towards deeply discounted stocks with relatively small downside and larger upside potential. I would say that my approach now is geared towards deep value, or an NCAV approach, which naturally drifts toward smaller caps- preferably service firms, some cyclical and asset-based companies (land, real estate). As a Canadian investor, these are quite difficult to find within the TSX, so I often have to look in the American exchanges. I have yet to fully explore other foreign markets. Every now and then, I tend to search for bigger, good-quality companies hoping to find a bargain, and I now hold a greater amount of cash.
Of course, my investing strategy is continuously evolving- as is everyone's, and I have no bias against good-quality, well-established and moated companies selling at discounts, I just research more deep value.
7. Name some of the things that you do or believe that other investors do not.
This is a great question! Things I do particularly would be that I usually think of the worst-case scenario during the analysis of a stock, and how I would objectively take actions post-purchase, additionally, what lessons I would learn if I were wrong. When purchasing a security, there are always two parties, a buyer and a seller. I always tell myself that everyone else is just as smart, if not smarter, than I am, so when I do make a decision- I am extra careful and remind myself that I can very well be wrong- which emphasizes my reliance on margin of safety. Furthermore, when I work on my valuation models, I try not to emphasize its importance because estimating certain aspects, such as rate of growth and earnings, with laser precision is nearly impossible (at least for me).
Ultimately, I feel that a big portion of investing is about yourself and your own honesty- of course, all this is purely my own opinion. I try not to be the next Warren Buffett (Trades, Portfolio) (as much as it would be nice), but rather I strive to be the best version of myself.
8. What are some of your favorite companies, brands or even CEOs? What do you think are some of the most well-run companies? How do you judge the quality of the management?
My favorite companies are what I define as quality companies; those that have a long-term horizon, are efficient, heavily moated, adaptable, increase shareholder value over time and, more importantly, honest. Some of these companies include Berkshire Hathaway (BRK-A) (BRK-B), Coca-Cola (KO), Wal-Mart (WMT), Google (GOOG)(GOOGL), Apple (AAPL) and the list goes on.
To no surprise, my favorite CEO is Warren Buffett (Trades, Portfolio). Others to be named are from the book "The Outsiders," which are Bill Anders, John Malone, Tom Murphy and the list goes on.
It is hard to define "well run," every company is different; some in different stages and industries. For instance, Delta Air Lines (DAL) has great operations- it is "well run" in relation to the nature of the industry- but the industry itself is very capital-intensive and hard to have a significant advantage over competition. Of course, quality companies are not always a good buy if they are overvalued- nor does it mean I will hold them. We must always think value in relation to price.
To me, quality management is based upon optimal decision-making and integrity. Judging the exact economic value added from a good management team is hard to gauge. Long-term past performance record in relation to economic events (booms, busts) should be an adequate indicator (I want to know how they performed in good and bad times). Other qualitative factors can be found in reading annual reports and filings. Overall, I do not emphasize management as much as the nature of the business operations- this is not to say management is unimportant.
9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
I do use screeners, some from Morningstar and Bloomberg - no heavy emphasis. I think there are plenty of ways to find undervalued businesses by researching 52-week lows, researching cyclical sectors and reading investment ideas (other individuals have great ideas- but do your own research, too). By nature, small-caps and over-the-counter stocks will have the most undervalued businesses. Searching in smaller caps is a good start.
10. Name some of the traits that a company must have for you to invest in, such as dividends. Talk about what the ideal company to invest in would look like, even if it does not exist.
A company must absolutely be undervalued before I can consider it. Depending on the nature of the business, I would value it based on its asset valuations, then earnings power, then growth potential.
The ideal company would be one that is selling at a deep discount to its intrinsic value, say price-net net working capital of about 50%, it has a positive NI, does buybacks (historically), insiders and top-tier management historically have ownership and has a few upcoming catalysts. Additionally, it helps if the company has a simple business model that I can understand and relatively easier assets to value (land, buildings, holdings).
11. What kind of checklist or homework do you utilize when investing? Do you have a specific approach, structure, process that you use? Or do you have any hard cut rules?
I do not use a specific checklist, but companies that have the components mentioned earlier are considered. I do my very best to build models and valuations from scratch for anything that catches my interest. Structure wise, I always read the balance sheet first, then the income statement, then cash flow. These can easily be found through SEC filings. I usually read the most updated (recent quarter), then the previous fiscal years. No hard cut rules.
12. Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?
As previously mentioned, I seek out information from the balance sheet, income statement and cash flow from various sources like MorningStar and Bloomberg, but I mainly use SEC filings. After my own valuation, I usually make a decision on whether or not to invest in the company. I do not talk to management.
13. How do you go about valuing a stock and how do you decide how you are going to value a specific stock? When is cheap not cheap? If you can, give some of examples.
I mentioned valuation earlier. Cheap is not cheap if the company is burning through its cash and has no foreseeable measures to counter that. In this case, the margin of safety on a stock will quickly deteriorate. Another case is if it has no way to operate profitably in the future. Unforeseen liabilities and loss of sales (a big account) will render a company not cheap in the future (in relation to a current valuation).
14. What kind of bargains are you finding in this market? Do you have any favorite sectors or avoid certain areas, and why?
There are always bargains available with enough research. I am looking mostly within the U.S. exchanges and the TSX, so my scope for deep-value stocks is more limited. Sector wise, I like service firms (they can expand and contract alongside the economy), smaller financials, real estate and some cyclicals. There are deep values in biotechnologies, but I tend to avoid them as I do not have a deep understanding of this sector. I avoid areas that make me scratch my head.
15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
I have no particular feeling about the overall market. It is what it is. I have a high focus on U.S. stock markets and the Canadian market. I think their large-caps are priced accordingly, perhaps with a slight premium, and some stock valuations are absurd, but generally it is not overvalued nor cheap- purely my opinion. The interest rate hike might affect valuations and reverting back to the mean might take place, but that is not something I am overly concerned about. What will happen with the economy next? I do not know and neither does the next person. What will happen to the stock market this upcoming year? As J.P. Morgan puts it, "It will fluctuate."
16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?
I am currently reading " HBR's 10 Must Read on Strategy" by Harvard Business Review and "Zero to One" by Peter Thiel. I write about business lessons and concepts from books on my site.
If you have any recommendations, please do contact me. I love sharing ideas and learning new concepts.
17. Any advice to a new value investor? What should they know and what habits should they develop before they start?
I would say to keep an open mind, be creative and be yourself. Do not buy something you do not know. Every investing style has their own unique merit. Equally, if not more important, read and learn as much as you can. Practice, apply the knowledge by actually analyzing the company yourself, build your own models and valuations, strive for continuous growth and remember that nothing of value comes easy. We are human; we make mistakes. There is always someone better than you - so be honest and humble. Make time your friend, not your enemy.
18. What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
Resource wise, there are plenty of articles written over the internet; here on GuruFocus, Seeking Alpha, WSJ and countless others. I use Excel as my main valuation tool. I try to keep things simple, complex models do not necessarily yield a more accurate forecast or valuation. Borrowing ideas are fine, but you must absolutely do your own research.
19. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?
It did take a bit for me to develop a better mental aspect in investing; when I started off with more volatile and risky investments, it would keep me up. But, learning and striving for growth paired with time has done its magic. Ups, downs, crashes, corrections and fluctuations are what make the stock markets. We can profit from them in many ways. Now, I am not particularly affected by how the market fluctuates. If I am right, time will tell; if I am wrong, again time will tell (but hopefully I recognize it early). I have no particular emotion towards the markets - it is what it is. I think being honest can help manage the mental aspect. For instance, if you feel like selling the stock because it took a drop, ask yourself what factual rationale is compelling you to make that decision- and if its fear (be honest), well you will know what you need to work on.
20. How does one avoid blowups in value investing?
Extensive due diligence and a sound rationale may diminish blowups. Minimizing leverage and avoiding it altogether would definetly help too. Prioritizing capital protection over seeking profits would be a logical solution. Concentration in poor companies can be a reason for blowing up (this is not to say you must absolutely diversify).
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This article first appeared on GuruFocus.
