Many investors are pessimistic about the prospects of their investments in the coming year. In this regard we are looking at the process of choosing deep value investments. We see the pessimism in that stocks are rising on tepid earnings reports as The New York Times reports.
Late last month, chip giant Advanced Micro Devices reported disappointing financial results for the fourth quarter and warned that its first quarter performance would be weaker than expected. The stock surged 20 percent. A couple of days later, General Electric reported one of its skimpiest quarterly profits of the century, badly missing analysts’ forecasts. The company’s stock posted its biggest jump in nearly a decade.
In recent weeks, numerous companies including Wynn Resorts, Ford and JPMorgan Chase have missed Wall Street forecasts, only to see their stock prices rise.
It’s a classic relief rally.
In other words, investors expected further reports of bad earnings, were bracing for such reports, and were relieved that things were not as bad as anticipated! That is a heck of a way to start out the year! If you are good at choosing deep value investments, you will pick stocks that have been or will be beaten down and which will recover and provide you with great earnings and dividends for years to come. If you are not so good at choosing deep value investments, you will lose money time and time again.
Deep Value Investing
What is deep value investing? Several years ago CNBC explained the concept.
PIMCO defines deep value investing as investing in stocks that are significantly undervalued based on their intrinsic worth (determined by asset-based or cash flow valuation).
When you find such an investment, it will typically have been unfairly punished by the market for any of a variety of reasons. Thus, its share price will have fallen and investors who see the falling share price may punish it further in the belief that the stock is ready to collapse. When this stock is a potential deep value investment, the market is not looking at its intrinsic stock value but rather at short term market price performance.
Deep value investing is a great concept and very profitable if you can do it right. Warren Buffett famously made a huge investment in Coca Cola at the end of the 1980s when the stock was languishing at 82 cents a share (factoring in stock splits since then) and today a share sells for $49 today. The Coca Cola dividend has a 3.16% yield based on the current price. That works out to be $1.55 a year. This is nearly double the share price when Buffett chose KO as a deep value investment! Choosing deep value investments and doing it correctly leads to great long term profits. The rub is how to do the job properly.
Choosing Deep Value Investments
One way to do this is to follow the advice of others. For example, Seeking Alpha recently touted 3 deep value dividend stocks that they believe will beat the market over the long term. The three picks are CVS Health, Qualcomm, and Vodafone. Here is the summary of the article.
Deep Value contrarian dividend stocks can be a powerful investing strategy that leads to both great income and market-crushing returns.
But investors have to be careful to weed out good opportunities from yield/value traps that could lead to permanent losses or chronic underperformance.
Qualcomm, CVS Health, and Vodafone are three deep value dividend stocks my new portfolio bought this week, because I’m confident the market is excessively bearish on these companies.
While each has very real risks investors need to be comfortable with, ultimately I’m confident that from today’s deeply discounted prices you’ll enjoy a safe dividend and great returns in the future.
From current valuations (28% to 45% discount to fair value), I expect each of these companies to generate at least 18% long-term total returns.
So, how does this analyst go about choosing deep value investments? They stick to blue chip stocks that have recently lost ground in the market and which are strong on fundamental analysis.
It is a long article with a lot of detail but the bottom line is the need to distinguish between beaten down stocks with value and just plain value traps that will eat up you money time and time again. When we wrote about intrinsic stock value, we noted that this valuation is based upon projected future cash flow. Going back Buffett, he uses this approach continually and has been quoted as saying that he and his associates throw out 95% of the stocks they look at as too tough to call.The “Oracle of Omaha” insists on understanding how a company makes its money and how its business model will result in continued profits for years to come. He has tended to avoid tech stocks because he cannot predict the future of tech beyond a couple of years and his preferred holding period for a stock is forever!
So, if you want to walk in the steps of a master investor go ahead and see what folks like Seeking Alpha are suggesting. Then do your own analysis of a company’s fundamentals. Do not be afraid to throw out most of the investments you look at as “too tough to call.”
How Long Term Is Long Term Investing?
Choosing deep value investments fits in with a long term investment strategy. Your chosen company has been beaten down by the market but is still making plenty of money. Its management seems to understand what they need to do to keep the company moving ahead and are not resorting to tricks like buying back huge blocks of stock to support the share price or artificially inflating their dividend in order to attract unwary investors. How long will it take for this stock to regain share price? How long will it take to replicate Buffett’s experience with Coca Cola? We once asked how many years will it take to make an investment long term. The answer is that it takes at least 5 to 10 years for market fluctuations to average out and reveal the true long term value of an investment. This is the time horizon when choosing deep value investments.