STREET DOGS

From Behavioural Value Investor, Five Places to Search for Hidden Profits:

1. Cyclical businesses. Where there are no structural issues affecting the company but the business is deeply cyclical. At the low point in the cycle, the company’s then current profit levels will be far below its cycle-average levels. If the problems are purely cyclical, it’s just a matter of time until the cycle turns and the company achieves the level of profits it is capable of in a more normal external environment.

2. Turnarounds. Most turnarounds do not “turn”. It has been estimated that two-thirds of companies experiencing a company-specific decline in profitability fail to reach their previous level of results. There are cases when the turnaround has become more certain than not, and yet the financial results have not yet reflected this. The trick is to know what the key operating metrics are that “show” the company’s management has been able to right the ship.

3. Bad business/good business. Imagine a company with two divisions. Division A makes $2, B is losing $1 and the company overall is making $1 in profits. The market frequently values the company based on that aggregate level of profitability. What if management shows signs of selling, spinning off or shutting down division B? Then that company might look like a bargain before the market adjusts to the new reality.

4. Good businesses in investment mode. The best corporate managers try to maximise long-term profits. Frequently that might involve investments that are being expensed in the current period which will only bear fruit several years down the road. The result is that the current level of profits is not representative of the company’s true earnings power.

5. Early stage proven businesses. The key word here is “proven”.