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Jeroen Bos was a disciple of the legendary investor Peter Cundill and has since 2003 managed the British fund Church House Deep Value Investments. Over the past five years, he has underperformed his benchmark index; 10.9% annually compared to 19.1% . The book was published in 2013 and describes Bos’s investment philosophy through 15 case studies.
BUY ASSETS AT DISCOUNT. The deep value philosophy is to invest in discounted assets. This is done by buying shares in a company whose market capitalization is lower than its net assets, or even better, lower than its net cash. This type of investment can only be made on the stock exchange. In the private market, owners would seldom sell their company below net cash or below the total net worth of assets.
ASSETS INSTEAD OF PROFITS. The deep value philosophy differs markedly from other investment philosophies as the focus is on assets instead of profits. A company’s asset base changes slowly compared to stock prices and profits, which are often volatile. It is rare for a company’s equity to fall by 50% over a year, something that is quite common for a company’s profit level. However, all assets aren’t created equal. The more easily realized the assets are, the more secure you as an investor can be in the carrying values. Cash, receivables and inventories are more liquid than fixed assets, which in turn are significantly more liquid than intangible assets.
“The markets short-termism and obsession with earnings is a common factor in creating good cheap shares for deep value investors.”
LOOK WHERE NO ONE ELSE IS LOOKING. Deep value investors must not be afraid to go where no one else goes – this is where the deep value stocks are. Bos’s portfolio usually consists of about thirty companies whose names are not known in “The City” and who also often are loss-making. He also likes to look at non-UK companies that are listed on the LSE as analysts and managers rarely have an interest in these companies.
“It is often said that this kind of equity investing must be quite risky. Unsurprisingly, I disagree! The companies may look distressed and be down in the doldrums. But we are largely purchasing liquid assets at a discount. It’s like paying £20 for a £50 note. If these deep value stocks drop further after we’ve bought them, it usually means a chance to simply buy more for less–£50 for £10 or £5. The long term is what matters. And quality will out: either other investors will notice, or other companies will swoop in for a buyout.”
SKIP THE ESTIMATES. By not focusing on the profits, Bos does not have to make any forecasts – something that very few anyway are good at. This means that he does not need to study the company in depth to understand exactly everything that drives sales and margins. He can focus on the balance sheet, invest and move on to the next case.
SHIFTS FROM VALUE TO MOMENTUM. Once a company reports improved profits and the stock picks up speed, Bos ceases to be a value investor. He instead becomes interested in what the markets expectations of the company. Bos will sell into an earnings-driven market, and then wants to sell when Mr. Market is in his best mood – when the stock is “priced for perfection”.
”To sell these stocks when they hit their net asset value, as some value investors would insist, would mean that my upside might only be some 10% or so. But by waiting for the earnings to re-establish again, they can easily go up 100% or 200%.”
DEBT COMES IN DIFFERENT FORMS. Not all interest-bearing liabilities carry the same risk. Bos has been burned on companies that have a large overdraft facility in relation to the asset base. In tough times, it is not certain that it will continue to be granted – which can put the company in liquidity problems overnight. Bos prefers to see short-term as well as long-term debts that expire on a certain date – they do not disappear just because a financial crisis arises.
AVOID INDEBTED COMPANIES. Bos is careful with heavily indebted companies. Although the margin of safety may seem large, it can change quickly through a combination of large debts and a deteriorating market climate. He also believes that it is of great importance to review the pension debt. In the United Kingdom, it has gone so far that some operating companies have taken on the character of a pension fund with an associated ancillary activity.