Deep Value in Brazil – The Novel

From Making Silly Mistakes to Method – Acceptance of Risks and Proxies

Yes, my beginning was terrible. I lost a Mercedes-Benz, as I said in the post at the top of my blog.  By nature, I am extremely afraid of risks.  I would never be able to finalize any analysis. I always had to know more about something.  It meant that it was very hard for me to start any investment based on the merits of my own knowledge.  Despite serious advances in knowing investment philosophies and techniques, almost all the times I was copying someone else (see the Chinese Philosophy in the page Who is Baby Herman).

I had and still have, the problem of doing all the work on my own.  It is almost impossible to gather alone all information that is necessary to have a good analysis if you have a full time and time consuming job (as I do).  Maybe, the sole exception to this fact happens in a serious crisis, when the good old Graham net-net may work. 

Sincere Lies Interest Me and Known Risks Too!

As the Brazilian singer Cazuza said, sincere lies interest me.  And it has to do with risk.

To a certain extent, I had to accept my own limits and embrace risks.  But how could I do something that is so distant from my very nature?  Well, I had to better explore the kind of risk that frightened me.  I learned that I am afraid of unknown risks.  This subtle change makes a lot of difference. 

I looked at the past to know the risks.

But, since there is no guarantee that the future will be like the past, quite the contrary, I know that I am lying to myself.  But it is sincere!  And sincere lies interest me!

Knowing Risks

The acceptance of risks came together with the technical study.  Today, the main influences I have are:

1) Tobias E. Carlisle – Deep Value.  This book was a kind of a revelation (I know it sounds a little bit slushy, but that is true).  Obviously, Carlisle taught me method, the acquirer’s multiple, but more than that, the reasons behind it.  It is kind of understanding that you can rely on several proxies to make your investment decisions.  Wonderful book, I highly recommend it.  A shorter version of Deep Value, that also is a wonderful book, is The Acquirer´s Multiple”.  Also, Carlisle has an excellent site: acquirersmultiple.com.

2) James P. O’Shaughnessy – What Works on Wall Street.  Another wonderful book, full of ideas and a very clear concept, about your base case.  You have to have a base case.  If you have one, your risk is not unknown. 

3) Joel Greenblatt – The Little Book that Beats the Market.  Somehow this book is the “father” of Deep Value.  This book is incredibly clear (and fun to read!).  Also taught me to deal with proxies and some very simple and obvious concepts (but sometimes very hard to realize!) such as why value and price are not the same. 

4) Wes Gray and Jack Vogel – Quantitative Momentum.  The better explanation that I have read so far about value and momentum.  Careful deep research made available to the general public.  Also, they have one of the best investment sites I have ever seen: alphaarchitect.com.  They take empowering investors through education really seriously.

5) Pim Van Vliet and Jan De Koning – High Returns from Low Risk.  Very clear book (and fun to read too).  I exchanged some emails with Jan de Koning.  Jan, thank you very much! You gave me some very clear and practical explanations.

I have to mention the some Brazilian managers too!  Reading the letters of Orbe (now Trópico) was very important.  Thanks, Fernando Luiz!  Henrique Bredda has a real life approach that deserves applauses as well. 

All the authors and books above are only part of what I researched and read.  But somehow all of them allowed me to find a path that I rely on (and that has been lucrative so far). 

Now, I still can lose money, but if I do, I will do it with method! And it makes a lot of difference…

Long Live the Past

I decided to see whether Deep Value would work in Brazil.  In view of the size and age of the Brazilian market several adaptations had to be made.  Size of the companies, inclusion of utilities, concept of liquidity and few others.  In any case, for the first time I had a real – and sound – theoretical approach to investing.  In other posts I can better develop the theoretical approach, but I really recommend reading Deep Value.  It is hard to have a better explanation about it than the book itself. 

One issue to decide was the date of the start of my study.  I use Economatica (a professional database heavily used in Brazil), that has a database that goes back to 1986.  However, since Brazil severely suffered from hyperinflation until 1994 I decided that I would go back until January 1995, the beginning of the first full year after the adoption of the Real, the current Brazilian currency that killed hyperinflation.  I know that the period covered is short if compared to studies about the American market, but I could not find a better solution. 

Below you will find a chart comparing the return of one of the theoretical portfolios since May 20, 1995 until March 14, 2019 and Bovespa (the main Brazilian stock market index):

DVABR means Deep Value, strategy “A”, Brazil.  In this strategy the portfolio has 20 stocks, held for one year.  At the end of each year a new portfolio of 20 shares is formed.  At the formation of every portfolio, each stock represents 5% of the total.  There is no exclusion of microcaps, but to assure that stocks are actually traded I demand presence in at least 80% of the trading days and some trading volume (around R$60k per day in 2019).  I know these numbers make no sense for an institutional investor, but they work for me.  After all, I´m small.  I am working in some other studies to see the performance for small, mid and large caps. 

Below I show the theoretical performance of my real portfolio since October, 18, 2016. How can it be theoretical and real at the same time? The chart assumes the reinvestment of dividends, but this portfolio is too small to allow me to do that. My real performance was 175.54% between October 18, 2016 and March 14, 2019 (a performance higher than Bovespa). Another note about my real performance. Today, this portfolio is part of a larger portfolio, so I lost track of the real reinvestment of dividends. It means that my real performance should be a little higher. Anyway, the more I invest, the closer the real return of the portfolio will be to the theoretical one.

Next Steps and Help!

I believe that superior knowledge can lead to better results (lucky is always welcome). In the investment arena, this means superior knowledge about your investments. However, I have been unable to do it by myself so far.  Thus, I´m here looking for help.  In the meantime, I have been using a tropicalized version of Deep Value in Brazil.  I got to start somehow.  You need to have real money involved.  To be a voyeur sucks.  Real action is necessary!

But I know my limits.  Some necessary next steps are kind of obvious. Here they are: (i) further testing of Deep Value in Brazil and (ii) Deep Value as a screening method (instead of this kind of accidental quasi-Quant that I became).  Let me explain myself:

Testing Deep Value. I risk being fooled by randomness. I doubt I have tested the method, and some of its variations, in Brazil as many times as it would be statistically relevant.  Despite this important flaw, I am still using it with real money because I believe in the practical and theoretical foundations of value investing and the method has been tested in other markets.  In any case, further testing of this Brazilian version of Deep Value would be very much welcome.

Second Degree Investor. To use proxies is part of life.  I will never have full information.  To be more precise, I will never be close to have full information.  But, if Deep Value works, it is because someone is doing the hard work.  I want to be there. 

The mechanical use of the Deep Value does not see the details of the financials, for example.   If I had more manpower, it would be possible to select stocks with the method, better analyze them and only after this second layer of analysis make the final selections. 

We could also back test this “refined” Deep Value, analyzing sometime in the past to see if we really get superior results (yes, it would be Herculean work).

If anyone is interested in working together with me, please send me a message.  It will be a pleasure to share the work with someone.  Other ideas are welcome as well!

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