Deep value investing is a very specific sort of value investing -- the kind that "scares value investors," according to this segment of "The Morning Show" on Motley Fool Live. During the episode, recorded on Dec. 21, Fool analysts Jim Gillies and John Rotonti discuss what deep value investing is and what the key drivers are for true deep value investors.
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Jim Gillies: Deep value has a wibbly wobbly, specific meaning. It is not in any way, shape, or form Zoom or DocuSign or anything else that Cathie [Wood] owns. Deep value generally starts with a misunderstood asset value. You need something to support. Because deep value stocks look like they're priced for death, Fools, most of the time. I say this as someone who has run two, two-and-a-half deep value services for The Motley Fool over the years. Pay dirt, for sure. I got airdropped into special ops when the original advisor departed. Tom Jacobs left and I was put there for six months or so before we launched something else. I have brought deep value principles to Hidden Gems Canada as well. This is my lane. Growth stock's not my lane. I absolutely know that. Cathie Wood's team and most other people are far better than me at growth stock analysis, but you are in my neck of the woods now, Cathie, and you are flat-out wrong, because you cannot say to me that DocuSign, let me just pull it up here, DocuSign, fine company, as I've said on this program before. Built a better mousetrap. I bought houses before without DocuSign, I bought houses now with DocuSign. There is no question what the better methodology is. Equity plans. Equity plans pre DocuSign, equity plans post DocuSign. DocuSign is better. We're not saying that DocuSign is not a fine company. DocuSign at 15 times sales and unprofitable? It's not unprofitable because things have broken at the company and management needs to turn around and so it looks much worse than it is. They are unprofitable because they're hosing out equity cookies to insiders. This is a company that spent a hundred-plus percent of the free cash flow it generates to buy back stock, and the stock is still diluting at 6, 7 percent a year. Run that through your DCF, Maria. Maria is like no, because I know the answer. [laughs].
John Rotonti: Deep value is a specific subset of value investing.
Gillies: Yeah. It's the value investing that scares value investors.
Rotonti: In its traditional form, it's cigar butt investing. It is finding a stock that you think has one puff left on that cigar. One puff that can give you a 20, 30, 40, 50 percent pop before the cigar dies forever. I've spoken over the years, Jim, to a handful of true dyed-in-the-wool deep value investors and their guiding principles are 10 times free cash flow, so 10 percent free cash flow yield.
Gillies: Ten times the value. You're doing more metrics.
Rotonti: You're exactly right. First of all, they want to value that balance sheet. You're exactly right. Hidden asset value.
Gillies: Its balance sheet investing rather than income statement investing.
Rotonti: It's balance sheet investing. You're trying to reproduce what it would cost for a competitor to recreate that balance sheet, so reproduction value of that balance sheet. It's exactly right. It's balance sheet investing, it's net asset value investing, but then, statistically, they looked at 10 percent free cash flow yield, they look at 10 times earnings, and they looked at less than one times book value. Statistically, those are the metrics that drive true deep value investors.