Reddit user DeepFuckingValue (DFV) invested $53,000 in GME stocks and calls in 2019. Today, his position is worth more than $40 million. This article summarizes his investment style so that you too, can find the next diamond in the rough.
DFV is a value investor that uses technical analysis (using price charts to determine price direction) to time his entries. Value investors typically disregard technical analysis while technical traders tend to disregard fundamental analysis. DFV finds an edge using both. DFV doesn't day trade and holds his positions for 3 to 24 months. His portfolio is diversified and holds 10 to 35 stocks at a time. During crises, he diversifies even more. In mid-2020, right after the market crash in spring, he owned more than 150 stocks. He aggressively targets 50-100% annualized returns and finds these returns in undervalued companies.
Determining a company's value...
DFV has his own spin on how to value a company. The prevailing valuation method these days is to use the discounted cash flow model. This model determines a fair price of a stock by estimating the company's future earnings. The higher the future earnings, the higher the fair price of the stock right now. This approach is championed by well-known NYU Finance Professor Aswath Damodaran, who's often called the "Dean of Valuation". DFV ignores the discounted cash flow method when valuing companies. His reasoning is that value is incredibly subjective, no one cares about an accurate valuation, the discounted cash flow model is slow and tedious to use, and value is just one factor in determining where a stock's price is headed. What matters most is the overall framework for picking stocks, of which an estimated valuation is just one piece of the puzzle.
So how does DFV value companies? Here's a quick rundown:
- FINANCIAL STATEMENTS: Use financial statements to determine whether the company's stock price is discounted relative to its business performance. Some examples of financial metrics to determine this are: price to share (P/S) ratio, free cash flow per share, and cash on the balance sheet. Take these metrics and compare them with other companies. For example, a signal that GME was overly undervalued was GME's P/S ratio, which was at 0.17 even in December 2020. In the same month, the SP500 had an average P/S ratio of 2.753.
- INSIDER BUYING: Insider buying is often a strong signal that the company is undervalued. Insiders are considered prominent company employees like C-suite executives that have a detailed understanding of the business and where it's headed. A large amount of insider buying, especially when the stock is selling off or a company is at an inflection point (e.g. transitioning to a new business model), is a telltale sign that the company is trading at a discount. According to DFV, it's a good sign when insiders are purchasing $200,000 to $1,000,000 of stock and anything above that is a very bullish signal. It's even better if multiple insiders are buying at the same time.
- INSIDER OWNERSHIP: Similarly to insider buying, another bullish signal is a high percentage of insider ownership. According to DFV, a good amount of insider ownership is anything above 20%. In my opinion, this varies across business sectors and you should always measure a company relative to its peers.
- FOLLOWING GREAT ANALYSTS: A great barometer to determine whether a stock is undervalued is to look at what other analysts are saying about it. An example that DFV brought up for GameStop is Scott Preston's February 12th article, "GameStop Stock Can Quintuple Within Two Years: Portfolio Manager", published in Barron's. SeekingAlpha is an excellent website for analyses by more hobby-ist analysts. DFV likes to find competent analysts, such as by reading their posts or even comments, and keep tabs on them.
- TERRIBLE-LOOKING PRICE CHART: Sometimes all you need to tell whether a company is trading at a discount is to look at its chart. If the chart has consistently looked terrible but is now showing signs of life, such as slowing bearish momentum or low volume consolidation, then it could be the only signal required to buy.
These ideas can form the basis of a fast valuation methodology. DFV uses this methodology to get a general sense of value for a large swath of companies and he tracks their valuations over time. In this way, when an opportunity arises, he's ready to get in.
Besides valuation, here are some other tidbits on DFV's investment style:
- USE TECHNICAL ANALYSIS: DFV believes that price charts are great for understanding the sentiment for a stock and recent price action helps to determine whether to enter a position or not. There are times when the chart is all you need to enter. According to him, some of the best trades start with a crappy looking price chart.
- DABBLE IN SHIT: Because DFV is aggressively targetting 50-100% annualized gains, he often needs to dabble in deeply undervalued stocks. In his words, he needs to "dabble in shit". This means that he's constantly on the watch for companies that look hopeless, where the stock's chart looks like everyone has given up, and then you want to dig in and understand if this is an overreaction. When a stock rebounds from hopeless to some hope, it rebounds hard. Just look at what happened with GME.
- KEEP AN OPEN MIND: Some traders avoid trading stocks where they don't understand the business or sector. DFV tries to keep an open mind and doesn't shy away from valuing a stock in a space he's unfamiliar with. The opportunity cost of spending extra time researching is tiny relative to ignoring something outside your area of familiarity when it could be a dirt-covered diamond.
- MEASURE YOUR OWN CONFIDENCE: Finally, the last criteria DFV mentions for entering a trade is to ask yourself how confident you are about it. All the other factors mentioned above should come together and give you a sense of confidence in the trade. Consider assigning a confidence score for each trade before entering, and avoid the trade if your confidence score is low.
I tried to summarize, as best I could, two videos that DFV published on his RoaringKitty channel about his investment style. I personally really agree with his methodology. I hope this will be helpful for you in developing your own methodology.