Value Investing: Where to Look for Hidden Value?

The essential task of a value investor is to determine the intrinsic value of a security in order to take advantage of the market’s mispricing. Value investing is an intellectual discipline, but it may be that the qualities essential for success are less mental than temperamental in that it demands patience.

In last week’s post, Macro & Microfundamentalist Value Investing: Does It Work?, we discussed macrofundamentalist and microfundamentalist value investing. The former focuses on broad factors that affect securities such as inflation rates, while the latter studies the history of a particular security, noting how the price has changed. Today, we’ll cover where to find some of these financial securities.

Many have the mistaken belief that companies that have performed well over the prior year or two are good bets for the future and hold the expectation that companies that have disappointed will continue to perform poorly, a process called extrapolation.

Yet, the opposite is true—over a two or three year period, yesterday’s out of favor stocks tend to outperform.

So, what are some places to look for value stocks? Look for securities that are obscure:

• Spinoffs from larger companies are a wonderful opportunity for investors who are not constrained by questions of corporate size.
• The end of the year has historically been a good time to buy value stocks that portfolio managers have tossed out in order to avoid listing them in their year-end report.
• Companies that have been doing the same, though growing slowly and profiting modestly.
• Stocks of smaller companies.

Undesirable companies include:

• Companies in bankruptcy or undergoing financial stress (unless reorganized)
• Companies in industries that are at overcapacity, industries that are at threat of legislative or regulatory punishment, etc.

To search for these investments, refer to company and stock databases, financial press for spinoffs, restructurings or bankruptcy filings. Another source is trade publications to identify which industries are distressed.

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