This guest post on why there are few deep value investors was written by Net Net Hunter member Jonas Åström. Jonas is a private investor from Stockholm, Sweden. Article image (creative commons) by huevocosmico, edited by Broken Leg Investing.
Deep Value Investors: Seek Loneliness
Sometimes, I feel so lonely that I’m ready to give up and change my behaviour. Don’t get me wrong — I enjoy being by myself, but this tortured feeling I have after months (and sometimes even years) of loneliness is horrible.
But then suddenly, one by one, others start to appear from out of nowhere. After some time, so many people have arrived that the situation has changed completely. I don’t feel lonely anymore; I feel overwhelmed. It is time to leave for loneliness again.
How could this happen, and why does this happen to me over and over again? Well, I’m a deep value investor, and that lonely feeling in the pit of my stomach is only one of the reasons why there are so few deep value investors. But why is that so?
By definition, there are very few people interested in the types of stocks that deep value investors seek out — and that makes for a horribly lonely existence. It is when the rest of the investment community has abandoned the stock and sold it down into the gutter that deep value investors step in and pick up the stock.
How Much Ugliness Can You Handle?
It takes a whole lot of courage — or even better, a well-defined buy and sell strategy — to stomach the ugliness of deep value stocks. Most people would never even consider such a strategy, despite its proven track record and downside protection. What is it that people are scared of? The 90% drop in stock price? You bet! That is enough for most people to not even get close to the stock.
Most deep value stocks have such a small market cap that mutual fund managers can’t build a position. A small fund of $100M with 30 holdings means $3M per investment. That would move the price of most net-net stocks too much, making it impractical to own. Obviously, this not a big problem for a private investor, but it means that it is uncommon for funds to invest in deep value stocks.
If you use a deep value strategy, such as the acquirer's multiple, instead of the net-net approach, you will find more mutual funds invested. The reason is that the acquirer's multiple uses the EV/EBIT or EV/EBITDA multiples to rank investments, and it doesn’t focus on the balance sheet. Having said that, in general terms, there are few professional investors that can invest in deep value stocks due to their mere size.
Trends Come And Go
One of the longest bull markets in history rages on, and there doesn’t seem to be anything stopping it. The market seemingly sets new all-time-highs on a daily basis. I can’t help but notice how investors adapt their investment philosophy to current market conditions. I see hardcore value investors abandoning their old rules and adopting momentum strategies. That is not strange, but probably not very wise either.
So why do they do it? Four words: Fear of missing-out. Most people underperform the market, and seeing others experience incredible success is very difficult. So, adopting a new magic strategy such as a momentum strategy is an easy solution. This drains the pool of deep value investors.
Home Country Bias — A Bad Habit
Most investors suffer from home country bias when it comes to investing — your home country is always better. Obviously, there is no currency risk, but apart from that, there are few benefits to just sticking to your home country. In aggregate, national economies more or less synchronize across the world, but there are always countries that experience much higher or lower valuation multiples.
In particular, it is true for the current market conditions, where everything seems overpriced. Therefore, as Peter Cundill says, there is always something to do. What’s great about home country bias is that there are few investors searching internationally. That is why deep value investors still find bargain stocks trading at ridiculously low prices.
By the way, a great resource for current worldwide market valuations (PE, CAPE etc.) can be found here: https://www.starcapital.de/en/research/stock-market-valuation/
Everyone chases high returns, and reading the financial press makes it obvious that there is no focus on the downside risk of an investment. Journalists and investors are 100% focused on the upside of every investment — and why not when everything keeps going up? Income and cash flow statements are by far the the most read parts of the financial report; few investors care about the balance sheet statement. That is a big mistake, as income tends to fluctuate a lot more than the balance sheet. Therefore, the most conservative and safe investments are investment valuations based on the balance sheet. This is exactly what deep value investors do — focus on downside risk. Deep value investing, therefore, is a strategy that not only gives tremendous returns but also protects your capital from permanent loss.
Be Bold, Be Different, And Be Risk Averse
If you go against the crowd and stomach the ugly, unloved companies from other parts of the world, you will be very lonely. Being lonely is a good thing in investing, as it allows you to find bargains. Be bold. Be lonely.
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