Financial Freedom: In search of deep value

Value investing uses the earning power of an investment to calculate its value. We estimate how much an investment can earn over time and then discount that back to the present to arrive at a value for the investment. 

The critical question is how much that business will earn over time. For it to be a value investment, we want to pay less than the value of the earnings. 

Deep value investing, in my view, adds a wrinkle beyond the business selling for less than the value of the earnings  power. For it to be a deep value, we want the investment to sell at less than half its value. That level of value gives the investor a margin of safety in case earnings do not immediately recover.

Consider this example: If we buy an investment at 1/3 off its value then we can achieve a 50% return. However, if we buy that same asset at 50% off its value, then we can achieve a 100% return. This is the magic of compounding in investing and why it pays to look for deep value.

 Market Dynamics

In 2021, sector after sector have failed and experienced losses of up to 60% or more. Meanwhile, the major indices such as the NASDAQ 100 and the S&P 500 have continued to set new highs through most of the year. In my opinion, there may be indications that a bear market is developing. 

First, the percentage of stocks now participating in the rally has fallen off greatly. At the end of September, the NASDAQ and S&P 500 had less than 35% of stocks in strong uptrends, according to my research. Secondly, throughout the year, safe-haven assets such as gold have continued to strengthen and draw liquidity from the broad market.

We have had more than a decade of underperformance by international developed markets, emerging markets, and  commodity producers. As a result, these areas are now relatively cheap versus US markets. 

Separately, governments are planning to increase their level of deficit spending to embark on infrastructure investments and a transition to clean energy. In my view, this increase in fiscal spending may awaken the long-dormant inflation genie.

Finding Bargains 

Since the commodities markets peaked in 2011, the US stock market is the only market that has done well. Where the US markets have gone up over 300% since 2011, international developed markets such as Europe are up a little over 80%, according to my research. 

Emerging markets and commodity producers have done much worse. Emerging markets are up about 40% while copper, gold and energy producing companies are all negative over the past 10 years. The commodity producers are negative even with the massive run up this year on inflation concerns. 

In my opinion, the following sectors are where to find value opportunities: international developed markets, emerging markets, and producers of copper, energy and gold/precious metals.

The copper and energy markets are likely to do well in particular in my view because of the focus on greening the environment. Gold and the precious metals producers may do well as inflation takes hold more firmly and investors seek to preserve the purchasing power of their wealth.

Photo Credit: Bonnie Moreland via Flickr Creative Commons


This publication may contain forward-looking assessments, which are based upon a number of assumptions concerning future conditions that ultimately  may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual  results to differ materially. This letter is provided as educational information only and is not intended to provide investment or other advice. This material is not to  be construed as a recommendation or solicitation to buy or sell any security, financial product, instrument, or to participate in any particular trading strategy.

The Standard and Poor’s 500, or simply the S&P 500, is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States. The Nasdaq-100 is a stock market index made up of 102 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market. The iShares MSCI Emerging Markets ETF seeks to track the investment results of an index composed of large- and mid-capitalization emerging market equities. It is a modified capitalization-weighted index. Investors can’t invest directly in indexes.