Deep value investing is all about buying bonds and stocks at a price below their net worth. Here, the focus is on the cheapest stock, usually from companies on the brink of bankruptcy.
While it sounds tricky, you can expect the best long-term returns for a value investment fund. Warren Buffett—among many other value investors—made significant earnings because of this.
What You Need to Know About Deep Value Funds
As an investor, you need to be familiar with two elements: a large margin of safety and a conservative valuation methodology.
When it comes to net-nets, the safety margin is the valuation methodology itself. This gives them prices that are conservative assessments of the company’s liquidation value.
Investment Strategies For Deep Value Stocks
Investors make money with deep-value stocks by breaking through market pessimism. It’s all about finding company stocks that have been undervalued by a wider margin.
To do this, you should try any of these three strategies:
This process was conceptualized by Tobias Carlisle, author and investor extraordinaire. It follows the formula EV divided by EBITDA.
Here, enterprise value is all about market cap plus debt minus cash.
On the other hand, EBITDA is all about earnings before interest, taxes, depreciation, and amortization.
This helps investors give a better idea of the cost of acquiring companies to avoid the usual traps. After all, this formula includes debt, which is one of the characteristics that affect the expected return.
Negative Enterprise Value
This strategy also makes use of EV. However, it aims to seek a business that has a negative number. This occurs when the company has more money than its debt and market cap combined.
Using negative EV analysis is a great way to achieve a solid financial return. That’s because these companies trade below their cash value. This means they have a big chance of reverting to their regular stock prices.
Walter Schloss Ultra
Walter Schloss is known to have a portfolio comparable to Warren Buffett. Like the Wall Street magnate, he focused on ‘cigarette butts’—even managing 100 cheap stocks at any given time.
After trading with net-nets, Walter set his sights on the cheapest business in terms of book value and trade activity (at/near 52-week lows).
Simply put, his style was to invest in the cheapest stocks since they tend to take care of themselves.
The ‘Ultra’ in this strategy is a twist about decreasing risk while improving returns.
The Ultra technique also refers to investing in companies with strong catalysts, insider buys, and share buybacks.
To do this, you need to search for stocks that are inexpensive compared to tangible book value. This will give you a wider margin of safety since you only consider the hard asset.
A favorite of many investors including Warren Buffett, net-nets are all value stocks that trade at a price lower than their net current cost.
Designed by Benjamin Graham, this personal finance strategy follows the formula:
Net Current Asset Value = Current Assets – Total Liabilities – Preferred Shares
This measure helps investors make a conservative valuation of a company since it disregards non-liquid assets.
Graham believed that this investment strategy provides a considerable margin of safety. After all, it’s buying a business that can liquidate itself and pay all its debts while leaving some funds to its shareholders.
The Long-Term Benefits of Deep Value Stocks
Many investors using the strategies above have proven that the best returns come from cheap, deep-value stocks.
When it comes to deep value earnings, nothing else comes close to the securities of Warren Buffet. Following Graham, he sought out the cheapest stock he could find. Given its substantial financial benefit, he enjoyed a 50% average throughout the decade.
And while Buffett enjoyed tremendous sales, he actually became a victim of his success. Because of his immense funding, he couldn’t invest in small companies the way he used to.
Despite this, value investors like Buffett continue to work in such industries. They beat the market by adhering to the core principles and investing in extremely cheap value stocks.
This deep value investor first dealt with distressed debt, i.e., company bonds valued for bankruptcy.
Even as he grew his $124 billion Oaktree Capital Management, its size didn’t stop him from gaining access to value stocks.
He did so by focusing on equities such as special situations. As expected, this led to the company’s growth rate of 23% in 25 years.
While you may not be a Warren Buffett or Howard Marks, you can still reap long-term returns from these growth stocks.
Remember: it’s all about buying a low-priced basket to book stocks and revalue them. An annual rebalancing of an equal weight portfolio helps as well.
Most importantly, holding a basket of stocks trading for 2/3 their price will help. This can give you an average return of 35%!