[Numerous articles have been tolling the bells for value investing over the past few years, but the truth is that while value has not been the best relative performer, increased market volatility and disruptive industry events have been feeding value portfolios for future gains. These portfolios can be seen as smart diversifiers against today’s manic clinging to all things seen as “growth” and astutely positioning for future drivers of earnings and key areas of shifting investor attention.
To further explore these deep value perspectives and investment opportunities, we reached out to an experienced value investor veteran, Harris Kempner Jr, president of Kempner Capital Management and portfolio manager of Kempner Multi-Cap Deep Value Fund (FIKDX). Adding the certainty of continuing and growing industry disruption fueled by innovation and new business models to the unchanging basic nature of stock markets that are prone to external shocks and investor cycles of fear and greed, a reassessment of deep value investing may be very timely.]
Bill Hortz: While you have said in other interviews that you do not waste time figuring out the overall dynamics of the market, you seem to be a follower of market disruptions. Can you tell us how following disruptions helps your deep value investment approach?
Harris Kempner: I guess the best way to put this is that disruptions sometimes cause significant panic selling in individual stocks or groups of stocks. One part of our approach is to look for these panics in the market and try to discern whether their effects will be temporary or longer term. Since we expect to hold individual stocks for 3–5 years, we can afford to be patient when this happens to find the best deep value companies that we can determine at these bottomed out prices.
We tend to see the world a little differently than other people do as we focus on looking at stocks that are washed out, unpopular, cheap for the wrong reasons. It is a distinctive skill set and practiced investment approach we have focused on for over 30 years. We are always happy when market or industry disruptions can bring great companies to our attention.
Hortz: Can you give us an example of a corporate disruptor or disruptions that you been following?
Kempner: Announcements from corporate leaders like Google, Apple, Facebook or any major company stating they are moving into a new space or industry can trigger panic selling through that industry. We were very happy when Amazon (AMZON) started mentioning their diversifying intentions into new areas, like supermarkets and health care. They are a great example of a company disruptor causing knee-jerk stock price overreactions in those industries. That’s when we start doing our analysis and do our shopping for best deep value and low down side risk companies in those industries. That led us to great companies to invest in at favorable price entry points at the time including Kroger (KR), Cardinal Health (CAH), McKesson (MCK) and Walgreens (WBA)—all thanks to Amazon.
As another type of disruption example, I also have been keeping my eye on the Iranian–U.S. conflict and what it might do to the price of oil and oil stocks. Energy stocks here are a good example of our view of things. I do not believe the almost religious affirmation that oil is going to be used less and less, and that there is a peak oil demand in the short term, 5 years or so. That view seems to be motivating a lot of investors around oil stocks. On the contrary, I think there are plenty of statistics out there that seem to indicate that there is increasing oil demand over the next 5 years. That is my analysis, and with the patience factor we employ, we feel that those stocks that have been completely out of favor will eventually be recognized as to having better growth prospects than they are recognized at this point. All the while, they are paying us well to hold them and be patient with strong dividends. When we have market disruptions, of the likes of Iran–U.S. tensions, we have the great opportunity of finding what are truly deep value opportunities within these already depressed stocks.
Hortz: In your analysis of pummeled stocks, what is the specific criteria for determining if they are bargains or deservedly cheap?
Kempner: In the first place, what we look for is investment quality from their credit point of view, having a strong record of management stewardship and consistently paying dividends that provide some downside protection. Then it’s determining a lower risk entry point. We never buy a stock unless it is trading within 20 percent of its 52 week low. For instance, if a stock’s 52 week low is 50, we will not pay more than 60 for the stock. And then we will buy in increments and average down the position if the opportunity presents, but never more than 3.5 percent of total portfolio by market value for any individual stock. Those are some of the technical things we always apply. The key, though, is that companies need to be understood in terms of their longer term future. Each different stock, and the industry it’s in, needs to be understood in terms of the path it is carving for itself, and there’s no single criteria for that. That is a unique analysis and journey we go through with every company.