Trying to mechanically reduce the process of discovering undervalued equities to a few value ratios such as P/B, P/E or EV/EBITDA can hardly translate into sustained outperformance of the broader market. If this was was the case machines would have replaced every single money manager long ago. At the same time prices for stocks screening favourably would be bid up and the opportunity would cease to exist. Unfortunately this means that a straight-forward checklist, purely based on a bunch of financial ratios, does not help at all.
To define the checklist that can be of help to outperform the broader markets it is necessary to first outline the playing field and from there answer the question of what has to be done to outperform the market.
I believe the playing-field looks like this:
MEI Pharma is an idea brought to my attention by a fellow value investor. Thanks a lot!
I believe that the essence of value investing lies in the uncovering of highly positively skewed bets. Such bets feature the favourable combination of very little risk for permanent impairment of capital and high reward. Value investors focus primarily on the mitigation of downside risks when evaluating whether or not a security is investible. Doing that they seek comfort in robust cash-flows or tangible asset bases that serve as solid lower bound to share prices. Only when it can be assured with reasonable certainty that the downside is minimal an investment awakens interest.
Pre revenue cancer therapy developer MEI Pharma exactly ticks this box. Immediate downside is very limited given the equity is trading at net cash, while the upside is a nice 7.5x. Continue reading