Strategy
As you may already know, I am on the hunt for investments with the potential to "ketch-up." What does this mean?
Punished Stocks
Most compelling investment cases often can’t be identified through strict input variables
When screening for stocks, I am drawn to those that have been heavily punished (see chart above). It’s worth noting that I don’t rely on mechanical screeners, as I believe the most compelling investment cases often can’t be identified through strict input variables.
Instead, I screen more intuitively, reviewing a broad list of stocks one by one. The companies that catch my attention typically have lost a significant portion of their market capitalization or are trading at very low single-digit multiples (see next chapter).
Most of these businesses are cheap for a reason—they might be facing rising costs and compressed margins, or they could be operating in a sector that the market currently dislikes.
My next step is to determine whether these challenges are temporary or permanent. I look at how the business is responding to these issues: What initiatives are they implementing? What is their outlook on the situation? Most importantly, do they seem to care about turning things around?
The foundation of my stock analysis is almost always rooted in “cheapness” or peak pessimism
The foundation of my stock analysis is almost always rooted in “cheapness” or peak pessimism. On rare occasions, I’ll come across an intriguing growth story—one that’s overlooked or neglected by the market. In such cases, I might apply softer criteria regarding valuation. However, these growth cases are the exception rather than the rule.
What matters
When I come across a stock with a heavily punished price chart, I conduct some high-level checks to decide whether it’s worth adding to my watchlist. This list is not exhaustive but provides a solid starting point:
EV < Market Cap
I look for situations where the enterprise value (EV) is smaller than the market capitalization. This suggests less leverage, a stronger balance sheet, or potentially a cheaper stock. High net debt increases a stock’s effective cost, as a portion of free cash flow must be allocated to debt repayment. This reduces the company's ability to reinvest in growth or pay dividends, which negatively impacts total shareholder returns.
Value
A discount to NAV—or better yet, NCAV—or a stock trading cheaply relative to expected earnings (e.g., EBT/EBITDA) can signal potential value. However, not all stocks can be assessed based on NAV, as some businesses are inherently asset-light.
Increasing Revenues
Many cheap stocks show irregular or lumpy revenues. However, when revenues start to increase consistently, it could signal that the business environment or strategy is changing for the better.
Cash Flows
The company should have positive cash flow, with minimal CapEx, unless significant CapEx is intrinsic to the business model (e.g., store owner-operators). Some businesses are undervalued because they lack accounting profits during growth phases, despite generating strong free cash flow.
History of Profitability
A company that is cheap for a reason but has a track record of profitability may be facing temporary challenges or could be in secular decline. It’s crucial to determine which scenario applies.
Outstanding Shares
I prefer companies with a stable number of outstanding shares and avoid those with a history of dilution. Sometimes, a stable share count may suddenly spike—this could indicate a significant transformation effort. It’s worth investigating whether this push is promising or concerning.
Peers
Analyzing peers provides valuable context. Is the business model profitable for competitors? Are they achieving similar results but with a different approach? This can highlight strengths or weaknesses in the company’s strategy.
Predictability
How predictable is the company’s future performance? Is the business model simple and straightforward, or is it so inherently lumpy that it’s difficult to gauge where it stands in the cycle? Predictability helps in forming a clear investment thesis.
Investment-Cases, not Businesses
Money doesn’t care how it compounds
When searching for stocks, I don’t necessarily aim for "good businesses." Why? Because good businesses are rarely cheap unless there’s a special situation at play. Money doesn’t care how it compounds. Whether it’s through Apple stock or a struggling steelmaker, what matters is the return.
Instead of chasing good businesses, I focus on finding good investments: Situations where you get a lot while paying very little.
Thereby I am pretty agnostic concerning the type of business. While some types of businesses fall into the “too hard” pile, my investment universe is quite broad. I start by examining the price, as there are plenty of companies trading at a discount.
Forward Looking
A battered stock’s past performance is often just noise
When a business trades cheaply, it’s often because Mr. Market has little faith in its prospects. Maybe this is fair, because the company’s management has failed to deliver in the past. As a consequence, the market might expect assets to decline in value. Or the market believes the company will fail to meet expectations. This drives investors away and leaves the stock for dead.
Most investors like stocks only when they get up. But a battered stock’s past performance is often just noise. It reflects what went wrong in the past, not what could go right in future.
Turnarounds
Turnarounds are everywhere
Turnarounds are everywhere. Most cheap businesses need to change something to survive, and even good businesses regularly undergo transformations to stay competitive. Those that don’t adapt risk bankruptcy, delisting, liquidation, or becoming cash shells for other ventures.
Turnarounds can take many forms: a new Board of Directors, leadership changes like a new CEO or CFO, strategic shifts, better cost management, or operational reviews to uncover hidden potential. These changes often occur at the height of pessimism, when the market has given up hope.
Bold visions
Few companies are genuinely focused on creating and maximizing shareholder value. Ambitious companies often stand out in several ways:
Clear Revenue Targets: They set bold revenue goals for the next five years and have a clear plan to achieve them.
Incentive Plans: They offer stock options or incentive schemes with high-performance hurdles, aligning management’s interests with shareholders.
Expansion Goals: They target measurable growth, such as rolling out a specific number of stores or launching into new markets over the next decade.
Proven Leadership: They are led by a CEO or management team with a strong track record of compounding value at previous companies.
Identifying these signals can help you spot companies that are not just surviving but actively striving to thrive. Some of those businesses are cheap because they have disappointed in the past, but maybe it’s just their timeline that has moved.
The perfect stock doesn’t exist
The questions is not whether there is a catch but to know what the catch is.
The questions is not whether there is a catch but to know what the catch is. There’s no such thing as the perfect stock.
The most promising company might lack meaningful insider ownership. The cheapest stock may have weak management but a robust contracted order book for the future. A company with ambitious revenue targets could operate in a highly challenging industry.
Because the perfect stock doesn’t exist, I don’t focus on finding "good businesses." Instead, I treat every business as an investment case.
Plenty of time to observe
There are two extremes in the stock market. On one side, some investors rush to buy a stock, often because they’ve fallen in love with it. On the other, some seek complete information and choose to stay away entirely.
When I see value that appears obvious and the price seems too low, I start with a small position and dive deeper into researching the stock. In my experience there is no reason to rush as there is plenty of time to observe. Often, I follow a company for several months, observing its progress. Each RNS, news release, or interim update provides additional data points to evaluate whether the business is on track for improvement.
Some companies continue to fail to meet expectations, prompting me to exit my small position. Others demonstrate strong execution, which gives me the confidence to increase my investment.