Chasing the perfect cheap wave - finding “Trending Value” stocks.

I have been reading with great interest the excellent "Strategy Map series" written so eloquently by both Ed Croft and Megan Boxhall, 

As with all of Ed and Megan's articles, they are thought provoking and most importantly, lift us out of the day-to-day market noise to get us focused on investment strategy, rather than the daily claw scratching which can command so much of our time.

In order to access the entire series (great reading over the weekend AND MORE!) here are the links:

• Intro to the Strategy Map
• Compounding Quality
• Deep Value
• Contrarian Quality
• Breakout Momentum
• Trending Value
• Adventurous Growth

In one of the more recent contributions, Ed discusses the concept of "Trending Value" - the "strategy for opportunistic bargain hunters." I thought I would use it for inspiration for my latest contribution to the AFR (to be published next week) though I  would like to share it with you now. The article covers much of what Ed says, however it adds a slightly local flavour to it plus also coloqualises some of the more complex concepts. Enjoy the read.... but please spend some time over the coming week to read each of Ed and Megan's contributions.

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Chasing the perfect cheap wave - finding “Trending Value” stocks.

Buying stocks low and selling them high is a primal pursuit for investors. The reality for many trying to find deep value stocks is that it takes work, requires a keen interest in financial accounting and requires immense internal fortitude to maintain unwavering conviction, irrespective of how volatile price is.

Without getting into too much detail on how to identify deep value (editor note: read this article from Ed on the subject), the underlying premise is to buy into stocks trading at discounts to their intrinsic underlying value. These will be stocks often ignored by the market because they are either too small or have had / are having operational issues.

Value investors try to identify the price/value disconnect. As price often moves between over enthusiasm and over pessimism, the Value investor knows the true value is somewhere in between. So a stock viewed over pessimistically, through the passage of time and business improvement, will eventually revert back to a fair (intrinsic) value.

There are obvious risks when trying to identify value. The first, and most obvious, is that the stock may be cheap for a reason. Is it burning cash? On the cusp of going broke? Or is it at the top of its cycle (like coal stocks at the end of 2022)? Perhaps it is too small or tightly held for any institution to take a position?

Often in value investing, if something is too good to be true, it probably is. This is why value investors need to perform significant research in order to avoid dreaded “value traps.” Despite the effort required, the pursuit of value investing is keenly explored by many investors because if executed correctly, the gains can be large. 

For the majority of investors who don’t possess the time, inclination or patience to undertake such a complex and emotional taxing pursuit, there is an alternative. The concept of “Trending Value” is one where investors attempt to buy bargain stocks at the moment when price has started to turn the corner. They do this by combining the Factors of Value with Momentum so they can find stocks that are cheap and trending..

In terms of investing philosophy, normally these two factors are poles apart, however when combined can be used to find cheap stocks, that the market has started to cotton on to. This is in contrast to regular "Value only" investors who must expend a lot of energy and emotion to find something before everyone else.

A nice analogy for adopting a Trending Value strategy is like a surfer trying to catch a wave. They could choose to go to a beach where there are no other surfers, but equally no chance of catching a wave. Versus frequenting a more popular beach where waves are plentiful, as are the number of surfers. While you may have to compete with others, going out far enough and being patient means you can be one of the first to catch the magic wave when it appears.

If Value investing means cheap stocks revert to fair value in time, and if Momentum investing believes positive trends begets positive trends, then it makes sense that finding cheap stocks that are moving in the right direction, are the best way to mitigate many of the risks that Deep Value investing poses.

Trending Value investors also works best if there is a catalyst for the re-rate in the business. This will add further conviction in the stock and reduce some of the risk of picking a value play. Catalysts to look for include earnings improvements, stocks basing at the bottom of their current business cycle, directors buying on the cheap or a change in business strategy.

Below is a sample selection of stocks that we feel reflect the principles of “Trending Value” in that they possess a strong Value/Momentum (VM) ranking. As always, further analysis needs to be conducted to see if they suit the needs, liquidity and risk objectives of a specific investor.

* TTM - Trailing Twelve months

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