Deep Value: The Stock Market Strategy For The Brave

22nd May '23 by Edward Croft

21 comments 4819 reads

Imagine you're offered $1 for 50¢ - would you take it? Welcome to the world of deep value investing: where you try to buy stocks at a significant discount to their intrinsic value.

It sounds simple, but nothing ever is. The $1 note might be torn, and a bit inky. Your friends may warn you it's not even legal tender. Beyond that, parting with 50 cents today can seem tough if the wait to receive $1 is uncertain. Herein lies the problem. Mr Market may offer you a stock market bargain because he’s depressed, but there’s no guarantee that he’ll get excited again in the future. Perhaps this piece can help you find the patience, tenacity, courage, and contrarianism to take the deal. These are the traits you’ll need.

In this article we’re going to dive deep into Deep Value. Read on and you’ll learn:

The history of Deep Value investing and some of the luminaries gracing the field
The financial ratios and screening approaches needed to find these stocks
The risks and limitations that the canny investor needs to be aware of
The best books to read to further your knowledge.

Is Deep Value the right investment style for you?

This is a game custom made for the brave and contrarian individual investor. It’s a game that the professional investor struggles to play as so often the cards that are dealt out are small caps. Typically, stocks get cheap when the share price falls dramatically. As a result, the “liquidity” in the stock dries up.

As passive indexing has grown in popularity, mega passive index funds like Vanguard now manage trillions. Pressure on fees continues, forcing active funds to get larger and larger to compete. This leaves a dearth of professional investors hunting in the small and micro cap areas of the market. They just can’t play in this game, leaving opportunity for the bold individual investor.

Of course, tight liquidity is a double-edged sword. It’s hard to buy positions in illiquid stocks, and it can be hard to get out when markets fall. So nobody should play in this game with money they need in the short term or that they can’t afford to lose.

The opportunities offset these issues. In spite of periods of underperformance, Deep Value investing is one of the most consistent return sources in markets. But…

Unlock with Email

Unlock with Google

Already have an account?
Login here

Sovereign Individual

22nd May '23

Great article Ed. I would add Choose Stocks Wisely by Paul W Allen to that list of good deep value books and Routines & Orgies also by Chris Risso-Gill as a wonderful biography of the terrifically eccentric life of a true contrarian in Peter Cundill.

yiannos1

Another great article.

Mark Carter

In the early 00's I bought shares in Amstrad. About a third of the value was in cash. A few months later there was a takeover announcement and I made a nice bit of dough out of it over a short time.

I was following the "Dorfman Robot" at the time, and I remember making about 40% return one year. The rules are: an earning-to-price yield at least twice the AAA bond rate and total debt less than book value. I wrote about it a few years ago:

https://mcturra2000.wordpress....

Subsequent returns did diminish rapidly, though. I perhaps failed to appreciate that there is a time and tide for everything when it comes to investing strategies.

I seem to recall that if one had invested in the heavily indebted companies then you would have done even better. That up the risk, of course, and it depends on where you are in the interest rate cycle.

Richard Beddard publish a portfolio by some quite famous guy, who was an economist or something. Its strategy involved buying low-PE stocks, often with large debts. The strategy absolutely trounced the indices over a long period. Then came 2008, and they were virtually all obliterated. As the saying goes, it doesn't matter how high the numbers are generally, if one of them is a zero, then you're out of the game.

Maybe it's time to brush off the ol' Robot again.

Suggestions?

I'll go first. I hold Sylvania Platinum (LON:SLP, share that I seem to be riding all the way up, and all the way down. It's got net cash of $124m against a market cap of £226m. PE of 7.8, and P/FCF of 4.7, which is "hella cheap". The catch, perhaps unsurprisingly, is that analyst estimates are bleak and are trending downward due to the price of commodities. 2022 net profit was $56m. Analysts are estimating $39m for 2024. So buckle up on that one. Maybe the way to play it is to wait until the PBV reduces to about 0.5 - so about half the current level - where you're virtually all in cash. Don't pay attention to the PE in that case as it is likely to be misleading.

Edward Croft

I’d not heard of Choose Stocks Wisely - I will check it out!

282 in the US (a lot of these are Chinese)

Danger, Will Robinson, danger. A few years back we had a similar situation. Those Chinese companies were basically frauds.

It's also worth checking to see if the company is in the startup phase. It might have cash, but it burning through it and is likely to need more capital in future. I think it's better to look for "regular" operating companies that meet value criteria.

One area to look at might be bombed out sectors. Housebuilders were like that a few years ago, but not right now. Who knows, maybe we'll get a chance soon enough. There's a few housebuilders in the FT100, which I take as a warning sign that value is not yet available. When the whole sector bombs and a few need equity raises to shore up their balance sheet, that's a likely good time to invest.

@Mark Carter - I'm abroad at the mo, and away from my library, but Montier used to use 3 of those 10 Graham rules as one of his "Deep Value" screens. 2 of the 3 were the rules 1 and 6 you mention in your post.

Montier's best SocGen research papers were either rolled up into "Value Investing" and "Behavioural Investing". The former has some good pieces about net-net and Graham-esque deep value investing, especially through the financial crisis.

Sylvania Platinum (LON:SLP), and many other resources and energy stocks like it, seem to be suffering at the sword of ESG. I'm all for a green future, but it seems that the new lords of capital allocation (platform packaged clicks?) are starving essential sectors of investment.

Bouden54

Plus500 (LON:PLUS) another candidate, although not everyone's cup of tea. From memory, cash makes up around half of its market cap, and on a PE ratio of about 6 (even though it's delivered exceptional earnings growth since listing). They are now trying to crack the US market and there was talk of a US listing, so that could be a possible catalyst to drive a decent re-rating. Anyway, I recently bought back in after recent dip in share price.

ezlifeme

Very illuminating article Ed, lots of deep dive and links to screens and terms we (should) know, to illustrate the concepts covered - One of your best so far Sir

fluvac9

An excellent article, Edward : thank you very much.

Bookmarked and ready to be revisited a few times !

doctor dave

23rd May '23

Great article Ed. As a natural bottom-feeder this is right up my street. It does need patience though!! I’ve held N Brown, for example, for three years and I’m still awaiting the re-rating!!

And within Deep Value there is a lot of variation, from Ben Graham Deep Value checklist (up 38% since 2012) to Ben Graham NCAV (up 440% since 2012). Some bargains are better than others!!

What would REALLY help me though is MORE FOLIOS. Ten is just too few to be able to follow strategy results….

Thanks again for a great article.

Brilliant Leader

I’ll second that request for more folios. I find it one of the most powerful aspects of Stockopedia and would like to make more use of it with multiple portfolios for, like you say, testing strategies but also managing watchlists and a look through analysis of investment trusts and ETFs. I’m sure Ed mentioned recently that this enhancement was in hand or did I imagine that?

Epitychia

A great article. But would like more on the behavioural side in the next one. Takes nerves of steel to invest in these dogs.

yamaha865

Maybe B.P. Marsh & Partners (LON:BPM) could fit in here, discount of nearly 50% to last reported NAV and now over 40% of market cap in cash

Sheru The Vegan Westie

Hi Ed - thanks for a very detailed article :-)) - question if I may? So I thought I would explore/investigate further P/NCAV and P/NNWC using my current portfolio (screenshot below) as I am not familiar with these ratios? So I tried to view these values using a screen by adding both of these columns …. but as you can see from the screenshot below, these fields are empty for a lot of companies on Stockopedia? Am I doing something silly/wrong? :-)) thanks

24th May '23

Looking at the UK universe, only just less than half the market has a P/NCAV > 0.

The reason is that most companies have Total Liabilities greater than Current Assets. The basic formula is:

Net Current Asset Value (NCAV) = Current Assets - Total Liabilities.

(This is a simplification, as you should also subtract Preferred Stock, Minority Interests and ideally any off-balance sheet liabilities such as pension deficits and legal claims).

If you look at ACCO Brands (top of your list): Current Assets $882m vs Total Liabilities $1985m. So NCAV is negative.

You can't calculate a meaningful P/NCAV if the denominator is negative - so we set it as null.

It doesn't mean the company has no post-liquidation value of course, but from a Ben Graham "fast liquidation value"/net-net perspective, that only takes into account current assets, this kind of stock is not a candidate.

I know more portfolios is near the top of the list. A few things to work through first, but the product team will deliver in time.

Superstar - thanks for answering my question ;-)

25th May '23

More Folios seems to be one of the commonest requests over the last few years - maybe it could be promoted to the very top of the list???

1st Jun '23

Enwell Energy (LON:ENW) has been a classic net net situation. Annoyingly, I hadn't bought it when I was writing this Deep Value piece, but it's been on the NCAV screens as one of the more interesting situations, and it's been on my watchlist. It only trades about £15-20k daily, so not exactly easy to pick up shares.

East Ukraine Oil & Gas - so lots of issues operating out there, suspended licenses and legal troubles too. Got so cheap last week that on May 23rd it was priced at 15p at a P/NCAV of about 0.6. £77m on the balance sheet in cash and only a £52m market cap.

The next day it announced a 15p dividend - yep - it announced it was paying the entire market cap out as a dividend. The share price promptly doubled. It's now halved today as the dividend is due tomorrow - 30p minus 15p - back to 15p share price.

This is the kind of thing that happens in Deep Value. No idea if there are brighter minds out there who can figure out if it's still a decent risk reward play post dividend.

Given AIM continues to tail off, I think these kinds of deep value setups will continue to crop up in coming months.

5th Jun '23

Enwell Energy (LON:ENW) - Isn’t it about to disappear, with this being a last hurrah payment before delisting?

On that topic, can someone tell me what is the benefit of holding my Polymetal International (LON:POLY) shares in paper rather than on a distant bourse?

Thanks

Deep Value: the stock market strategy for the brave

Is Deep Value the right investment style for you?

Unlock the rest of this article with a 14 day trial

About the Author

Edward Croft

21 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...