Stock Selection Method Overview
Stock Selection Method
Exhaustive analysis is at the heart of what we do. Before investing in any company, we thoroughly study a company’s intrinsic or private market value.
Some of our methods for stock selection are detailed below.
Hidden Asset Method
Finding undervalued assets doesn’t happen every day, but it’s still worth looking. At Boyar Value Group, we refer to assets like buildings as “hidden assets” as they can be understated, obscured or even missing from a company’s balance sheet. One reason: Generally accepted accounting principles require companies to list certain assets such as real estate at historical cost, even though their value may substantially increase over time. That makes these assets difficult—or even impossible—to find by glancing at financials or using a simple stock screening tool. You’ll only find them through curiosity, patience, reading and old-fashioned elbow grease.
In addition to real estate, hidden assets can be natural resource reserves, off-balance-sheet investment holdings, and brand equities. Anything that might be overlooked during a cursory glance through a company’s businesses or financial statements may offer a hidden source of value. For example, we researched Stokely-Van Camp in 1975 when it was mainly known as a maker of canned baked beans. A review of its other holdings turned up Gatorade, which was relatively unknown at the time, but on its way to becoming a household name that today has a commanding share of the lucrative sports drink market.
Even a company’s name can steer investors away from its real value. In 1979, investors wouldn’t necessarily have recognized Binney & Smith as a household name. But they likely had a box or two of the company’s most iconic product, Crayola Crayons, in their house.
How do you Find Hidden Assets?
You need a combination of basic curiosity and stubborn self-discipline to find hidden assets, even though they’re often hidden in plain sight. You need to act like a detective and ask a lot of questions. And when you do identify an undervalued asset, you still have to decide whether to act on it.
When we uncover a hidden asset, we use it to help establish a private market value of the business, and then we look to see how that value compares to the publicly available market value. If the stock appears to be selling at a significant discount, we then look at how likely the company is to unlock the hidden value. Without a potential catalyst to realize the value of a hidden asset, there’s less reason to act on it.
The Bottom Line
Uncovering hidden assets is hard work, but that’s where the opportunity arises. The situations are unique, and the work is involved and intricate, from identifying hidden assets to estimating their true market value and, finally, assessing catalysts for capital appreciation (read: what’s going to make the stock go up?). But if you can find a hidden asset that has both the potential for and the likelihood of monetization, and the company’s stock price is discounting (or neglecting) its value, then going against consensus and buying the stock can mean taking an ownership position in a potential Stockley-Van-Camp’s or Tiffany’s.
Sometimes the most valuable opportunities are hiding in plain sight.
One of the first companies Boyar Research looked into in 1975 was Tiffany & Co., based off of a bit of curiosity as to whether or not the company actually owned it's Manhattan property. This curiosity led to some digging into the company’s public filings. That task took a bit more legwork in the 1970s than in today’s digital world, but we ended up finding that yes, the company did own the building.
We also discovered more: Tiffany’s market value at the time was $30 million. A quick calculation suggested the real estate was worth more than the company’s entire market capitalization. In other words, anybody who invested in Tiffany in July of 1975 got the value of the whole business—from the Tiffany trademark and its inventory to the world-famous Tiffany Diamond—for free. A little over three years later, in November 1978, Avon Products acquired Tiffany & Co. for $41.41 per share, a 452% increase from its $7.50 share price in the summer of 1975.
Great consumer brands are sometimes overlooked, or underappreciated, by the wider market when those brands as "hidden" behind an unassuming corporate name (think "Gatorade," which was once hidden under the umbrella of baked beans manufacturer, Stokley-Van Camp). This approach requires two elements:
- An iconic brand or franchise, which can offer competitive advantages that are nearly impossible to replicate
- A corporate name that "masks" this well-known franchise, causing a valuation discrepancy to occur.
We have found the franchise approach to be an exceedingly effective method of finding unappreciated value.
Business Value Method
Over the long run, stock markets are fairly efficient. In the shorter term, however, valuations can go to extremes both on the low and high sides. Investors usually create these anomalies by piling into whatever is currently in vogue and indiscriminately selling whatever is out of favor. For example, in 1992, a bubble in the pharmaceutical industry popped. On average, drug stocks lost 40% of their value as growth slowed and profits began to erode due to increased discounting and generic competition. Another shoe dropped when the Clinton administration attempted to enact healthcare reform, and investors began questioning the long-term profitability of the pharmaceutical industry.
Back then, we wrote an extensive report for our research clients outlining why we felt this series of negative events created a great opportunity to invest in pharmaceutical stocks. When industries fall out of favor, Wall Street sometimes drives the market cap of companies within that sector far below what an acquirer would pay for the entire company. That leads to buying opportunities for discerning investors with the patience to wait for the industry to right itself. Of course, it’s anyone’s guess when the tide might turn—investors may need to suffer through years of under-performance before these investments eventually pay off. It’s often well worth the wait, however. Investors who looked past the scary headlines and purchased stock in pharmaceutical companies during the uncertainty were rewarded when the industry bounced back a few years later.
Companies can enter all sorts of special situations that can cause investor sentiment to shift, either to the positive or the negative. Experience has taught us that two situations can be particularly valuable to look into:
- Recent Spinoffs can be a rich source of mispriced investments.
- Newly spun-off companies are often receive little coverage Wall Street analysts. This dearth of information makes it easier for valuation errors to develop.
- Situations may arise where shareholders of the parent company are forced by their investment mandate to sell off their stake in the newly formed company, depressing share prices below the company's intrinsic value.
- Companies emerging from bankruptcy can also be a source of undervalued situations.
- Such companies often suffer from both a lack of analyst coverage, and a general stigma. This combination can lead to situations where they temporarily sell at a discount to value.
Catalysts & Triggers
Finding an undervalued company isn't enough for us. Finding an undervalued company with solid fundamentals still is not enough for us. Stocks that are undervalued may remain that way for an extremely long period of time. This is why we keep digging, looking to identify a catalyst that could result in value appreciation within a reasonable amount of time (typically two-to-five years).
To put it simply: there is no reason to own stake in an undervalued company; unless you see an event on the horizon that could unlock that hidden value.
We look for many kinds of catalysts, but a few of the noteworthy ones include:
- The initiation of a dividend or meaningful stock repurchase program.
- A possible corporate split or spin-off that makes sense.
- Management changes, acquisitions, macro themes (i.e., demographics, housing recovery) and the resultant prospect for improved operating performance.
- A company controlled by an octogenarian with no heir apparent.
Avoiding Value Traps
Invariably, a group or sector falls out of favor and retreats to bargain basement levels as investors abandon ship. In these situations, value investors get to purchase stocks when they are on sale. However, investors must avoid falling into potential value traps by asking some key questions: Is the industry going the way of the dinosaur? Is the underlying product still in demand or have consumer tastes permanently been altered?
If we can answer these questions in the affirmative, in all likelihood a good buying opportunity has been created.
Weighing the Risks
Sometimes overinflated prices create incredible opportunities for value investors. Take the housing industry circa 2007: at the time, Wall Street couldn’t get enough of merchant builders. Share prices rose so high that we advocated shorting those companies. Four years later, after the bubble burst and housing prices fell to affordable levels, the prospects for a housing recovery looked promising. Furthermore, the valuations of housing-related stocks fell to bargain basement levels. But because we couldn’t predict the timing of an eventual recovery, we took extra care when reviewing the balance sheets of the companies we considered buying.
Merchant builders likely would have offered more upside in a recovery, but the amount of debt on their balance sheets made us pause. In turnaround situations, companies with excessive leverage don’t have the luxury of time to solve their problems. Too much of a delay could spell their doom, so we would need to be right both in terms of our thesis and our timing to make money on them. We decided to look for lower-risk opportunities in companies with sound balance sheets that could benefit from a recovery in housing market conditions, such as Mohawk, Whirlpool and Home Depot. That way we could take advantage of the eventual recovery without worrying about the exact timing, reducing the risk of bankruptcy that a levered homebuilder would have brought into the equation.
The Bottom Line
Many screens exist to help point you toward industries that have fallen out of favor. The key to finding value lies in determining why the industry has fallen out of favor, and whether those reasons create a temporary opportunity (like early 1990s pharmaceutical companies) or a permanent shift in fortunes (such as Polaroid’s failure to adapt to the digital camera revolution). Arming yourself with that knowledge and the confidence to buy when others are selling, along with the patience to stick with your investment until the turnaround unfolds, you may find opportunities to purchase the proverbial fifty-cent dollar.