Adhering to the Guiding Principles naturally leads one to search for investments:
· Wherever the majority is not looking.
· Wherever the competition is less (and you can gain an advantage).
· Wherever large institutional investors are acting on oftentimes silly and uneconomic restrictions. (Picking up elephant crumbs can be very rewarding; but be careful not to get trampled in the process.)
· Where few, if any, analysts publish research or cover the companies; which tend to be small and mid cap companies, but value can and will cycle between small, mid and large cap companies.
· Often buying what the majority does not want to buy (or are selling.)
Some examples of the above are:
Under-followed. Securities and industries not followed or “sponsored” by Wall Street analysts can often be mispriced because information is not as quickly processed and incorporated into expectations. Analysts and investors aren’t “coached” about the company and value.
Spin-offs. Spin-offs can be mispriced in the short term because analysts typically don’t begin research coverage until several months after trading begins, if at all.
Companies in a widely held Index may spin-off a separately traded company that is not in the Index. As a result, Index Funds (and closet indexers) often indiscriminately sell because they cannot own the shares. This may create short-term opportunity, leading to excellent short or long-term investments.
Stub Securities. Companies or securities are often liquidated over a multi-year period. The initial distributions can make up the majority of its value. The residual value (“stub”) may be insignificant to large institutional owners, who often indiscriminately sell the remaining portion of their investment.
Recently emerged from bankruptcy (Post-bankruptcy). Often the banks and bond investors wind up with stock of a recently reorganized company and indiscriminately sell. (This is not to be confused with “distressed investing” or in bankruptcy, which often has unresolved financial, legal and procedural issues.)
Fallen Angels. Where there was once greed and optimism amongst shareholders and analysts, there is now the opposite. Most often it is warranted. But occasionally it is not or the pendulum has swung too far.
Stocks selling below $5 per share. Many mutual funds and institutional investors cannot own stocks selling below $5 per share, no matter what their intrinsic value.
Statistically Cheap Securities. Regularly run basic computer screen for companies that have one or more of the following attributes: selling at (1) a large discount to “net net working capital” (a conservative measure of liquidation value), (2) a large discount to book value, (3) a low price to earnings multiple, (4) a low price to free cash flow, (5) management/insider buying, (6) company buying back own shares, (7) high dividend yield, (8) a low price in relation to cash or marketable securities (net of debt). Will screen for individual or combinations of these attributes.
Most of the names appearing on a screen will be cheap for good reason. The screen is the starting point. It’s like walking into a giant department store and having the salesperson say, “On the 2nd floor in the back right corner is all the stuff that’s on sale or being liquidated.” It’s a good place to start looking for bargains.
“Wonderful Business” at a Reasonable Price. Regularly run basic computer screen that attempts to capture the economic characteristics of a great business – including, but not limited to: (1) 5 year return on capital threshold, (2) 5 year return on equity threshold, (3) Economic earnings yield at substantial premium to 10-year corporate AA bond, (4) Company pays a dividend, and (5) Company buys back more stock than it issues. This screen is typically run for all 5 characteristics together and has repeatedly surfaced many great companies at attractive prices.
Follow Insiders and Smart Investors. No pride of authorship for a great idea - regularly monitor the investment activity of corporate insiders (not so much exercising options, but if they are buying stock of the company they manage in the open market with their own cash). Also regularly follow investment activity of (1) other like-minded value investors through their 13-F filings, and (2) 13-D filings of potentially activist shareholders buying or owning more that 5% of a company.
Follow Wonderful Companies. Keep informed about great companies and managements that you would love to own at the right price. The price may not be right today, but tomorrow it may go “on sale”.
Value Traps. Cheap securities are often cheap for a reason (sometimes obvious, sometimes not.) Management may enrich or entrench themselves to the detriment of shareholders, or make repeatedly poor capital allocation decisions, or the industry suffers fundamentally bad economics (long term return on capital is below cost of capital, thus destroying shareholder value – think airlines and autos), or the market cap may simply be too large for an effective catalyst to unlock value. Avoid such “value traps.”
Truffle Hunting. Like truffle hunting, if you know where to look, when to look, what to look for - and are disciplined and patient - every now and then you will find something of great value.