GO JEROEN?S WAY
UK investors interested in deep value can tap into the expertise of Dutchman Jeroen Bos, lead manager for the SVS Church House Deep Value Investments Fund (GB00B79XM025). This £9.6 million open-ended investment company (OEIC) is a small cap fund that looks for unloved companies priced at a discount to their liquid assets.
He recently took time to meet with Shares and explain his nvestment style, outlined in his book ?Deep Value Investing: Finding bargain shares with big potential?. In the book, Bos explains how deep value investors can unearth investments that are both very low in risk and high in return. Searching among the market?s unloved stocks, he looks for shares whose value is not justified by future earnings forecasts by analysts or hoped for by management, but by the current facts found on the balance sheet.
At bottom, Bos? goal is to find companies where the assets on the balance sheet outnumber the liabilities in such a way that the risk of investing in their equity is strongly mitigated and can be accurately estimated relative to the potential return. Bos wants to find so-called ?net-net investments?, first described by Benjamin Graham. A net-net investment is a share where the current assets of the company outnumber all of its liabilities.
Many shares trading at a discount to net asset value (NAV) are unarguably cheap, as they?ve gone through years of falling profits or contracting markets and boast scant potential for a turnaround. Furthermore, their balance sheets are usually light on working capital yet heavy on fixed assets, which means value is locked up in often obsolete plant and buildings. Statistically, such stocks are cheap, yet options for the gap between the NAV and share price to close are limited; in such cases, NAV can eventually fall as losses mount and the investor?s margin of safety evaporates. These are not the investments desired by Bos, as fixed assets tend to be illiquid and difficult to shift. Assets are all well and good, but liquid assets are what he is interested in.
As Bos explains in his book: ?Benjamin Graham?s classic really taught me what to look for in a balance sheet and how different assets affect the attractiveness of potential investments. The most attractive companies, according to Graham?s results, are the so-called ?net-nets? or ?bargain stocks?. The beauty with these value stocks is the prominence of their current assets. In the first instance, their fixed assets can be ignored completely.
By prioritising shares with healthy current assets, you find shares whose value can be readily unlocked. Current assets are by their nature a lot more liquid and for that reason can be sold off quicker than almost any kind of fixed asset. If we can find a stock whose current assets (i.e. inventories, receivables, cash etc.) minus its total liabilities are worth more than its current share price in the stock market, then we can talk of a stock that is trading at a discount to the net-net working capital position.? He adds: ?To put it a slightly different way, this is where the current assets minus current liabilities but also minus the long-term liabilities are still greater than the current market capitalisation. If that is the case, then we know on a statistical basis that are we dealing with a truly cheap stock. Even if it can never be sold off at a vastly improved share price, you still have a bargain on your hands. The assets are worth more than what you?ve paid for them. The icing on the cake is that we have not taken into account any fixed assets. They effectively can be said to come free at the price paid.?
Once a broker to the late Canadian value investor Peter Cundill, Bos? fund invests in firms with strong balance sheets, which creates a margin of safety, yet also those which are suffering from temporarily low profitability that can be improved. When sentiment is poor, such solid, yet cheap companies can be bought at attractive prices which can rise when profits return to previous levels, while buying companies at rock-bottom valuations means the fund can often benefit from takeovers, which Bos says are ?a great liberator of assets that are under duress?.