- Imagine you’ve found a neglected jewel which you expect that will ultimately capture an upside of, say, 75%...
- But, when will it happen? In 3 yrs, 5 yrs, 7 yrs..?
- Those periods equate to IRRs of 20.5%, 11.8% and 8.3% pa respectively.
- Assume a catalyst exists that’s successful in prompting a realization of that full 75% upside within 1 year. That is, of course, a 75% IRR!
How to find under-valued, out-of-favour companies at the point when the market is starting to recognize them?
- Discover a group of value stock by examine the price-to-book, price to-cash flow, price-earnings and price-to-sales ratios.
- Ascertain which of them are likely to rebound versus being cheap for a reason, such as being near bankruptcy.
- Look for sign of momentum
- in terms of price momentum (relative strength)
- in terms of improving analyst sentiment and earnings surprises.
Some examples of possible catalysts include:
- Fresh management with new direction
- A change in strategy of existing management (e.g. new product strategy, business reorganization or cost reductions)
- A disposal or purchase of a meaningful asset
- A recapitalization of the business
- A takeover bid, or
- Activist shareholders who may put pressure on management to act.
Screen Criteria
- At least one of P/B, P/CF, P/E or P/Sale more favourable than the industry
- 6 month relative strength (% gain vs S&P) > 0
- 3 month relative strength >= 6 month relative strength
- Earning suprise by examines three inter-related measures
- Standard earning surprise - most recent interims vs forecasts
- Abnormal returns around recent earnings announcement
- Revision in the analyst consesnsus - now or trending over the last 6 months
Diversification & Portfolio
- No one stock makes > 1.6% of the portfolio
- No single industry make up more than 3% relative to the weight in the corresponding benchmark
- Ruled out stocks than have been public < 2 years
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