The investing world is full of tough competition. Better results require hard work. Sometimes even hard work is not enough.
If you are looking for investment opportunities in the same places as everyone else, it’s difficult to get a competitive advantage.
Looking for only Standard & Poor's 500 stocks you definitely meet the world’s smartest minds. That doesn’t mean that you should completely avoid investing in any S&P 500 stock. After a stock market crash or heavy correction, it is often possible to find quality blue-chip stocks at discounted prices.
If you have the right kind of contrarian mind and strong nerves to invest heavily in high-quality businesses during a time of fear and panic, you can compound your money successfully over the long run. I did some of my best long-term investing in Wells Fargo (WFC, Financial) after the last financial crisis. In hindsight I should have used more money, but after the panic my mental fear was too big to overcome.
Unfortunately we are not all like Warren Buffett who was able to put over 50% of his assets to the most promising investments when all the odds were in his favor. I was happy to find Bank of America (BAC, Financial) and AIG (AIG, Financial) soon after Wells Fargo. After conducting my own deep fundamental analysis I have to admit that knowing Bruce Berkowitz (Trades, Portfolio) was investing heavily in these companies helped me get past the first mental obstacle.
Nordic markets
At other times, you probably find the best opportunities from less-followed frontier markets. I live in Finland, and all the Nordic countries (Finland, Sweden, Norway, Denmark) are more or less peripheral to big market players. Sometimes you can find little-known, underpriced, quality companies and smaller growth companies for reasonable prices. For real bargain hunters, Nordic markets are normally tough. You can hardly find any net-nets and most of the cheap stocks are bargain for a reason. However, after the market storms, small markets (typical for all Nordic markets) often suffer more than leading markets.
This can easily lead to strong undervaluation, and you can find unbelievably cheap high-quality companies. There are also some opportunities in a special situation sector. At this point I have to mention Seth Klarman (Trades, Portfolio), the founder of Baupost Group, who profited from Finnish Biotie Therapies' (OHEL:BTH1V, Financial) buyout. Klarman purchased Finnish Biotie ordinary shares in June 2015 on the Finnish securities markets before the company released its initial public offering to American Depository Shares.
The sun is shining far away
Also some other more unstable markets can offer special opportunities. Latin America is a good example. Political situations can change rapidly. Also business conditions are far from the levels of Western Europe or the U.S. This means that the risk level is higher, but if you do your homework well or you have some local knowledge, and you are careful enough (remember sufficient margin of safety), opportunities for high profits are more than enough.
The same applies more or less for Far East markets. Of course there are big differences between places like Hong Kong, Singapore, South Korea, Malaysia, Vietnam and the Philippines. You need a little bit of market knowledge, and you should look after companies, management and accounting principles. Quantitative investing doesn’t necessarily work so well because in Asia many stocks that are selling cheap are more likely to be in a lousy business. Qualitative deep knowledge of the management and the company is needed.
One famous Finnish fund manager Petri Deryng (Pyn Elite Fund) has been working successfully for a long time in the Far East region although last year, we got a good example of investing risks there. After the trading suspension of Chinese lottery company REXLot Holdings (HKSE:00555, Financial), Pyn Elite Fund had to make a big write-down.
Deryng was not the only one, and it was by no means a surprise for those markets. Before we condemn investing in the Far East as too risky, we should remember what has happened recently in the most reliable market with Valeant Pharmaceuticals (VRX, Financial), Horsehead Holding (ZINCQ, Financial) and SunEdison (SUNEQ, Financial). Some famous and traditionally respected big names have burned their hands. And I suppose you remember Enron and WorldCom – not so long ago.
I have had a couple of interesting positions from the Far East. At the moment, Nam Lee (SGX:GOI), net-net from Singapore, is an example of a good bargain stock in a solid market. Basically it is a family business that designs and manufactures metal products. Because of challenges in the metal industry it has had a couple of difficult years. It’s a boring but sound business.
The company was cheap and profitable. I bought it for a price of 28 cents in Singapore dollars (20 cents in U.S. currency)Â per share. The quality of its reported earnings seems to be fine, and the ROA was even 9.18%. The owners also appeared to be shareholder friendly by paying out a decent percentage of income as dividends. The biggest risk of Nam Lee may be its customer concentration and difficulty to name any special catalyst which will raise the stock price soon.
I am also looking for troubled economies in emerging markets. Big crash, financial or political distress can spell opportunity. I am prepared for them, following five to 10 stocks from a couple of different markets. Once an opportunity has been identified I can buy a basket of undervalued stocks from that particular country (this is little bit like the legendary Templeton way of investing in emerging markets).
Very special case
Russia is its own special case. Most Western or U.S. investors think that you should avoid Russia in all cases – and maybe for good reason. I do not entirely agree. In Finland we have learned to live with the "Big Bear" as a neighbor (a horrifying thought for some?). We have learned to do business with Russia – and even profit there.
From Finnish markets you can find many companies doing part of their business in Russia. The key word is part of their business. The risk remains moderate, and you still have a good upside possibility.
I have positions in Nokian Tyres (OHEL:NRE1V), Tikkurila (OHEL:TIK1V) and Neste (OHEL:NESTE). I made all these investments long before the Russia-Ukraine crisis. After the crisis and political sanctions, I took positions in Gazprom (OGZPY) and Sberbank (SBRCY) because of their ridiculously cheap valuations at the time combined with as stable a business background as possible in Russia.
Political risk is often impossible to value, but when I saw the military and political situations begin to stand still, I figured the possibility of the worst case is no longer as great. It’s easy to say afterward that this time valuation meant more than political risk. I have to admit that the opposite outcome was also possible.
Small is beautiful
Last but not least, small-cap and micro-cap markets offer the most opportunities for small investors. This is true everywhere in developed markets. Smaller companies are not followed as much by analysts, are often easier to understand and can create unique opportunities. You just have to do your fundamental analysis and remember the importance of margin of safety. Then you can successfully go against the crowd.
Many economic studies confirm that small equities as a group have offered attractive and better than average returns over long periods of time. These results can differ based on the time periods examined but in the big picture, small stocks outperform large stocks by a statistically significant margin over time. Without going too deeply into analysis of small stocks, there are some basic things you should take into consideration.
Avoid too tiny illiquid stocks. Trading could be difficult, and the bid-ask spread is wide. Sufficient daily trading volume (varies greatly from market to market) ensures the correct formation of stock prices. Annual and quarterly reports (U.S. SEC filings) should be up to date. It’s appropriate to require insiders collectively owning at least 1% of a company’s stocks.
The small stock space is enormous. The most effective way to narrow down the field of potential investments is often screening. For me the most interesting small cap area is net-nets stocks trading at a discount to their net current asset value.
Net-nets can offer the best investment results for a small investor. Even if you use a simple mechanical screen and buy-and-hold strategy, results can be outstanding. Basically all the net-nets stocks are cheap. When you have found one, you should concentrate more on the business than on the balance sheet.
Of course, balance sheet value comes in cash, which is more favorable than value in receivable or a high level of inventory. That is why Benjamin Graham used net-net working capital formula where net net working capital = cash and short-term investments + (accounts receivable x 0.75) + (inventory x 0.50) – total liabilities.
And finally, remember once again margin of safety. Father of value investing and margin of safety Graham purchased baskets of net-nets that were valued at a discount to their net current asset value by 33% or more. More about net-nets in the near future.
Disclosure: The author has positions in Wells Fargo, Bank of America, AIG, Nam Lee, Nokian Tyres, Tikkurila, Neste and Gazprom.
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