Deep Value is a quantitative investing strategy which selects for investment the cheapest stocks in the universe based on a valuation multiple.
Through our extensive research and experimentation, we have implemented a Deep Value screen (links to be added). The screen allows creating Deep Value Portfolios, customized to one own’s preferences. Our screen allows setting market cap limits, and apply filters which improve risk-adjusted returns significantly, such as a Beta filter and a Price Smoothness filter.
Enterprising investors willing to put a little effort in constructing a Deep Value portfolio using our screen will enjoy the following benefits:
- No management fee as with buying an ETF or a mutual fund
- Ability to build a small cap portfolio which is expected to yield better returns than mid-caps and large-caps which an ETF or a mutual fund would hold
- The improvements we’ve added to known models increase average returns and reduce volatility
- Complete transparency, coupled with control over major parameters of the model
Note that the two caveats of constructing a portfolio quantitatively are a) the increased effort (having to rebalance any year or so), and b) slightly higher taxes (relevant only to taxed accounts), resulting from rebalancing the portfolio every year or so.
Follow the following guidelines to construct your own version of Deep Value portfolio using the Deep Value Screen.
- Examine the initial list of stocks. The list consists all the stocks in the universe
- Set up the market cap slider according to your preferences. For example, to limit market cap to $300M and up, set the left edge of the slider to 300 and the right edge all the way to the right
- Filter the results for low-beta. For example, to remove the 30% of stocks with the highest beta, place the upper limit of the “Beta3Y Rank” on 70
- Filter results further for Price Smoothness. For example, to remove the 75% of stocks with the most jittery performance, place the upper limit of the “Price Smoothness” Rank on 25
- Sort the results based on the valuation rank you chose by clicking on the selected column title. It can be EV/EBITDA, EV/EBIT, VC2 or any other valuation multiple you choose
- Buy the top (=lowest valuation multiple) stocks in the filtered and sorted list
Rebalance and Sell Rules
Every rebalance period apply the screening rules described above. We recommend one year for most investors and six months for aggressive investors operating in tax-delayed or tax-exempt accounts.
Simple Sell Rule:
- Let’s assume you own a 30-stock portfolio. For each stock holding, if the stock is not included in the top (-cheapest) 30 stocks of the current screen, sell it
- Calculate the money available for each new holdings as follows –
Available Cash / (Target # of stocks – Current # of holding)
- Buy the highest ranking (=cheapest) stocks on the screen which you do not hold (based on the valuation rank).
If you have decided to implement enhanced Sell Rules to increase returns and reduce asset turnover:
- Sell stocks for which the valuation rank is lower than your defined threshold. In our examples, we sell stocks only if their valuation rank goes below 80.
- To increase risk-adjusted returns further, examine each holding’s financial information and sell positions in stocks that meet one of the following criteria:
- Trading now in OTC. Stocks start trading OTC when they fail to adhere to SEC regulations of major exchanges.
- The company have been unable to report its financial results for six months or more
- The price has fallen below $0.9
- Common Equity has turned negative
- Buy the highest ranking stocks on the screen which you do not hold (based on the valuation rank)