Monday, November 18, 2013

Value Investing: Prepare for the deep dive with Jeroen Bos

Today Michael is sharing his first thoughts on the recently published "Deep Value Investing: Finding bargain shares with big potential" by Jeroen Bos. 

The strategy detailed by the author is not for the faint-hearted and requires discipline, patience, attention to details and a certain degree of comfort with unloved stocks. All the ingredients one would expect from value investing in one of its purest form. Enjoy the read and get inspired.


Value investing is more art than science, and there are a number of important books that describe the principles underpinning the art. This year alone, at least 3 such books have been published. In contrast, there are relatively few detailed and recent case studies on value investments.

Deep Value Investing by Jeroen Bos fills the gap. It deals with a particular species of the value school. Target investments typically trade below the value of their current assets less all liabilities (so-called "net-nets" à la Ben Graham). No wonder these stocks are ugly, unloved, under-researched, ... and hence exciting!

The author, a former stockbroker turned investment manager in 2003, specializes in UK small caps with a penchant for asset-light businesses. He describes himself as "cheap and stubborn" and seems to possess the right mindset for deep value investing.

Each of the 15 case studies presented in the book is covered with a consistent approach (company background / investment case / outcome). The fact-based analysis starts with the balance sheet and continues with highlights from company results and announcements. Very helpfully, the book is accompanied by an appendix with 586 pages full of detailed disclosures about the analysed companies.

The results are spectacular: the average return of the 15 investments is 1.9x, including 2 failures (RAB Capital and Abbeycrest). The holding periods vary but were generally short (half of the investments were sold within a year). One investment (ArmorGroup) was sold after 4 months for 3x.

Throughout the case examples, the reader is exposed to a number of key value tenets:
  • Stay within your circle of competence: for Jeroen Bos this clearly means small, UK services companies, including recruitment companies (Spring Group), defense contractors (ArmorGroup International, Morson Group), engineering companies (Velosi, Norcom), financial specialists (RAB Capital, Record).
  • Focus on the balance sheet: Jeroen Bos first looks at the balance sheet, more specifically at net-net working capital. Earnings are secondary.
  • Buy discipline: virtually each of the 15 companies was bought below its net-net value.
  • Sell discipline: interestingly, unlike most value investors, Jeroen Bos does not necessarily sell when his investments reach fair value. He prefers to wait even more until some earnings momentum develops and the investments moves from an asset play to an earnings play (for instance, homebuilders Barratt Developments and MJ Gleeson, which had a fantastic run lately, are still the top 2 holdings of The Deep Value Investments Fund managed by Mr. Bos).
  • Catalyst? It strikes me that the notion of a catlayst is absent in Deep Value Investing. Buy cheap enough and good things will happen. And indeed: a number of investments became (accidentally?) M&A targets, sometimes shortly after Mr. Bos invested. 
The last six chapters of the book are devoted to companies Mr. Bos still owns. Two of them are still net-nets today (French Connection, Norcom). Another one seems very interesting to further explore (Record).
At a time when bargains are so difficult to find, Deep Value Investing provides great inspiration to hunt for low risk / high return investments.