I recently missed a multi-bagger stock - the kind that rises several-fold. It reminded me yet again that pure value investing is harder than most people think. That's because value lies in more than merely a low price-to-earnings ratio or a low price-to-book value. Rather, it consists of a security selling so cheaply that the chances of losing money on it are very low.
Of course, anything so cheap is probably being shunned by everyone, or no one would be selling it. By definition, then, if you want to buy an extreme bargain, you must, first, go against the entire world's opinion (which just may be right), and second, base your buying on original digging that you do yourself.
These twin requirements are much harder than most realize. Indeed, it is because they are so hard that occasional bargains exist.
All of the above came to mind when I recently beat myself up for having missed the rise of Zarlink Semiconductor Inc. Long ago the company was called Mitel. I got my first ranking as a top tech analyst many years ago when I correctly rated it a "sell,' and so I remember it fondly.
After many rises and falls and corporate transformations, Mitel became Zarlink. It was active in many small electronic markets, with high market share in each, which limited its growth. It also had some real estate and an ancillary business. The company stagnated and the stock drifted below $1. I paid it some attention, but it kept drifting lower, below 75 cents, below 50 cents, and so I forgot about it.
Finally, in March of 2009 it fell to 23 cents. Foolishly, I disregarded it. Big mistake. The chief executive officer of yore, who knew the company well, came back, cut costs and sold assets. The many small markets were reduced to the three best, and the stock began to rise. Today it is close to $2, an eight-bagger from the bottom two years ago.
Is the stock still all right? Maybe. At 11 times earnings, one times sales and 2.6 times book value, it's below the valuation of some comparable companies. But it is no longer the bargain it was at 23 cents.
Now why did this come to mind? Because recently I once again perused Seth Klarman's book. Mr. Klarman, to the faithful, is one of the purest value investors around. He once wrote a book about value investing, regretted giving away his secrets, and bought back most of the copies. Today a copy goes for $1,200 on eBay.
Based on the book, Mr. Klarman's approach is uncompromising: He buys only absolute bargains, where his chances of losing money are very low. Hence the name of his book, Margin of Safety, echoing Ben Graham's original concept.
Warren Buffett, on the other hand, whom many consider a value investor, has modified, if not deserted, the value approach he once employed. At the extreme, value investing is, in Mr. Buffett's own words, like buying a three-puff cigar butt for the price of one puff, and selling it for two, leaving the remnant for the final holder. The cigar is merely a butt, intended for a one-time gain.
This is how Mr. Buffett started investing, until his partner, Charlie Munger, convinced him to modify his approach. Instead of looking for more one-time gains, Mr. Buffet instead began looking for steady businesses that would keep growing, and buy them only when, once in a blue moon, they suffered non-terminal problems that made their stock temporarily cheap.
Please note, though: cheap, not value. These are often two different things. Cheap implies a high-quality company selling temporarily below its true worth, while value implies an outright bargain, no matter the business quality. Mr. Buffett does the first. Mr. Klarman does the second. Both have outstanding results. But they don't always do the same thing.
Once in a while, a situation may arise that encompasses both approaches. Zarlink may have been one two years ago, and I missed it.
How not to miss such bargains in future? Keep your eye on fallen, unpopular stocks, and check if the underlying business is still good. If it is, ask yourself what rock-bottom price you'd pay for it - and write it down, because one day it may just get there.
Avner Mandelman is a director of Venator Capital Management and author of The Sleuth Investor.