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Robert Abbott
Robert Abbott
Articles (486)  | Author's Website |

Modern Value Investing: 11 Places to Find Bargain Investments

Some types of situations open up buying opportunities that most investors never see

January 29, 2019 | About:

If you are a value investor, you are also contrarian to some degree, so you cannot just look for stocks by following the herd. In chapter nine of “Modern Value Investing: 25 Tools to Invest With a Margin of Safety in Today's Financial Environment,” Sven Carlin mapped out some unique sources of value investments.

Tool 25: How and where to find bargains

The author offered the following areas as generators of bargain stocks:

  1. Catalysts leading toward a fair valuation.
  2. Corporate liquidations.
  3. Complex securities.
  4. Accounting complexities.
  5. Risk arbitrage.
  6. Spinoffs and initial public offerings.
  7. Small-cap value stocks.
  8. International markets.
  9. Sector cyclicality.
  10. Hyperbolic discounting.
  11. Bottom-up investing.

1. Catalysts are events or changes that are reasonably likely and, if they occur, will lead to higher valuations. For example, a poorly run company that would produce much higher returns with better management--if there was a boardroom shakeup or a takeover. Other catalysts might be less dramatic, such as a dividend increase or recapitalization.

Carlin explained, “Finding a bargain that has some triggers that are going to unlock the value separates the investment’s reliance on market forces, speeds up the unlocking of value, and increases the margin of safety.” He added that catalysts allow investors to realize profits and reduce risks; the latter occurs because the gap between underlying value and market value is closed before new, aggravating events can occur.

2. Corporate liquidations involve a complex set of circumstances with a great deal of uncertainty and, as a result, the stock of companies undergoing them tend to be depressed. As Carlin put it, perhaps only one in 20 distressed companies might be a good investment, but finding that one would be worth it. Any attached catalysts would increase the potential gain even more.

3. Complex securities are for “diligent” value investors prepared to put in lots of time and effort. Because of factors such as multiple share classes or holdings in other companies, mispricing is not unusual. Carlin pointed to the case of Yahoo in 2015 as an example. It held a 17% stake in Alibaba (NYSE:BABA), $5 billion in cash and a 34% stake in Yahoo Japan. Despite all that value, the market was pricing Yahoo shares at less than just its stake in Alibaba.

4. Accounting complexities, in particular generally accepted accounting principles (GAAP) versus reported earnings, can leave most investors confused. An investor who understands accounting might find many otherwise unknown value stocks by doing the math, so to speak. Carlin had this to say of Apache Corp.’s (NYSE:APA) 2015 reporting: “APA’s management managed to turn a loss of $23 billion into an adjusted loss of $130 million and even finish with positive adjusted EBITDA of $3.9 billion. It is practically impossible for an investor not specialized in accounting to understand what is real and what is not in such an annual report. Unfortunately, Apache Corporation is not an exemption [exception?] in the corporate world but more of a new mainstream.”

5. Risk arbitrage refers to the strategy of finding temporary market mispricing, in cases where the gain or loss is subject to the results of a business transaction such as mergers and acquisitions. This frequently involves the need among the buying and selling companies to get regulatory approvals. The author likes situations in which the acquisition price is still less than the company’s intrinsic value, saying risks are limited and can lead to quick profits if the deal goes through. If the deal falls through, the investor still owns an undervalued asset.

6. Spinoffs and IPOs: Spin-offs can sell off at “irrationally” low prices because many shareholders prefer to stay with the mother company and sell their spinoff shares too soon. With IPOs, stock prices often drop after the stock's debut because the market has not yet recognized the company’s value (witness Facebook’s (NASDAQ:FB) IPO).

7. Small-cap value stocks have a market capitalization between $300 million and $2 billion or $2.5 billion and their shares are selling for less than book value. Such stocks are quite often takeover candidates, have the potential for faster growth than larger companies and often are not followed by analysts. Investors who are prepared to do their own analysis and commit their capital for the long term can do very well with small-cap value stocks. But patience is essential; investors may have to endure low liquidity, greater uncertainty and more while waiting for the market to finally recognize a company’s potential.

8. International stocks are a variation on the same theme as small caps. Securities beyond the home country are often little known, and investors may sell all their assets in another country because of political or economic turmoil. Carlin recommended buying stocks that have tangible underlying assets: “Owning a hotel on the most famous Greek beach or close to the Parthenon will always have its value because tourists are going to continue visiting such places, as has been the case for the last 2000 years.”

9. Sector cyclicality involves both economic cyclicality and prices that are driven by a big player in a sector. Regarding the former, Carlin wrote this of mining company Rio Tinto (NYSE:RIO): “For me it is incredible that a stock of an established and diversified miner such as RIO can go from $20 in 2005 to above $80 just two years later, only to fall to below $10 in 2008, quickly rise to above $50 in 2010, drop to $20 in 2015 and then again quickly rise to above $50 in 2017.” Value investors can take advantage of the market’s “myopic” attitude.

Turning to the case of prices being driven by the largest company in a sector, we frequently hear of situations in which stocks across a sector are all pulled down by a hiccup or something more serious by a bigger company.

10. Hyperbolic discounting is an idea from academic Richard Thaler, a Nobel prize winner, and refers to a tendency among people to prefer a smaller reward that comes sooner rather than a bigger reward that comes later. In the case of investing, “the value a company will create in the future is discounted at a much higher discount rate than the value it will create in the short term.” For example, a long-term project that is scheduled to be completed in the distant future will likely be heavily discounted by investors with short-term horizons.

11. Bottom-up and top-down investing refers to two basic strategies. Most investors take a top-down approach by making predictions about the future, especially in a bull market. Bottom-up investing by value investors mostly ignores forecasting and instead focuses on fundamental analysis of past results. That includes the standard metrics such as price-earnings ratios and book values. For example, Bank of America (NYSE:BAC): In 2011-12, it had a book value of $20.24 per share, but shares traded for as little as $5. Carlin wrote, “The point is that a bottom down approach allows you to take advantage of market irrationalities with minimal risk.”

(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution." In his book, "Big Macs & Our Pensions: Who Gets McDonald's Profits?" he looks at the ownership of McDonald’s and what it means for middle-class retirement income.

Visit Robert Abbott's Website


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