This article on deep value investing strategies to avoid industry bias was written by Net Net Hunter member Bryan Shealy. Bryan worked in the inventory business for 5 years which gives him an edge in net net investing. Article image (creative commons) by 3844328, edited by Broken Leg Investing.
With the market at all-time highs, you should be filthy rich! Are certain deep value investing strategies holding you back? The key is to focus on the industries that deep value investing strategies work best on.
Did you know that you have an industry sector bias? It’s interesting — I didn’t realize it until I saw it. Depending on where you live in the world, or even where you live within any country, you may be overweighting your portfolio by favoring certain industries.
It is quite amusing really. I live in California and I own a lot of technology stocks. Little did I know that I was actively participating in this sector bias. Take a look at this graphic:
Image: Likelihood of owning stocks in an industry according to region (source)
Not only am I more likely to invest in technology, but I’m less likely to invest in industrials or energy. After taking a look at my portfolio, I noticed that of all the companies I owned, only a few could truly be considered undervalued, and they were both energy and industrial stocks.
This led me to think about how my own industry bias was holding back my deep value investing strategies. I’ve held on to my technology stocks telling myself that they are undervalued. But why did I think they were undervalued?
It is mostly because there is a lot of misinformation going on in the technology sector. Hedge funds and analysts want you to buy these companies, even if they are overvalued. They compare these stocks to their industry peers. This not only rationalizes sector bias, but can also be outright destructive to your portfolio if the industry you invest in is overvalued.
Liken technology stocks to growth stocks. They have no business being considered value in most cases. Why? Because much of their book value is intangible. They deserve a higher valuation. However, many of the strategies we use at Broken Leg Investing actually don’t even look at intangibles. They are a bonus! Just like all long-term assets, there is no reason that technology stocks can’t be included in our deep value investing strategies, but we need to make sure the industry as a whole is not overvalued and we don’t rationalize to keep investing in an overvalued industry.
The problem is, today’s leading industries will usually be tomorrow's losers. The economic cycle guarantees this. Just look back a few years to the dot-com era. Post dot-com era technology stocks were extremely undervalued. Some of them were even net nets! This is most definitely not the case for these types of stocks today. By identifying my own industry bias, I was able to lessen my concentration in an industry at its peak and find much better opportunities in other industries.
Why Adding These Deep Value Investing Strategies Will Improve Your Portfolio
The deep value investing strategies that we most employ seek out undervalued assets using various tactics like the Acquirer’s Multiple or Ultra stocks. Most of the stocks uncovered are in underperforming industries.
Warren Buffett’s famous quote, “Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing,” really drives this point home. Why should we diversify out of undervalued industries? If we want to maximize our returns, we should really look at the most undervalued industries.
I must warn you that this information is more qualitative than quantitative, but why would you invest in an industry that is outperforming? If you have two stocks under consideration, all else being equal, it would make much more sense to invest in the one in the underperforming industry. The reasoning behind this theory is the underperforming industry has much more potential for appreciation once money flows into the sector.
The deep value investing strategy that I’ve been talking about employing is sector rotation. Sector rotation is an investment strategy that takes advantage of weak industries and attempts to beat the market. As a deep value investor, this gives us great potential for wonderful finds and greater price appreciation.
Don’t Ever Invest In These Industries!
While sector rotation is a great addition to our current deep value investing strategies, it is important to note that some industries should never be touched by value investors.
These insidious companies disguise themselves as amazing value companies. They have a ton of extra money from their constant funding rounds. However, the money is not used for expanding the business or operations; instead, it’s used for research and exploration. The industries I am referring to are biotech and resource exploration.
It’s true that these types of industries have amazing potential, and some individuals have made an excellent living by speculating in them. Notice, I said speculate. Biotech and exploration firms more often than not fail in their endeavor to find the next cancer medicine or massive oil deposit. The bottom line is that most have not found them — and may never.
Biotech Is Not Healthcare; Resource Exploration Is Not Industrials
While it's important to note that the above industries are ones that we should definitely avoid, it does not mean the industry type cannot be confused. Biotech companies that actually produce a product can be undervalued and valuable investments. However, if you decide to invest in a biotech company, it is important to realize that these are more qualitative investments. They require knowledge of what drugs they currently produce and which ones they have in the pipeline to boost revenues.
Exploration is not the same as an active oil drilling company and the industries that support it. In fact, many of the undervalued industrial companies reviewed by Broken Leg Investing are beaten down energy stocks. The key here is to determine whether or not the opportunities under your microscope have actual operations. If their operations include searching for oil reserves or even beginning construction, it’s best to stay away from these cash-burning enterprises.
Deep value investing strategies have no specific industry that they work best on. The key is to avoid those industries that have no significant operations. If a company has no history, how can it be a value? It is important to take account of your own industry bias, since it may hold you back from finding true value opportunities.
Broken Leg Investing can help you discover ways to overcome your own sector bias. Enter your email address below because we’ll send you inside info on the best performing deep value investing strategies today PLUS a free copy of The Broken Leg Investment Letter.