What is deep value investing?

Tim Travis is the CEO/CIO and founder of T&T Capital Management, an investment advisory located in Orange County, California. T&T utilizes a deep value investment approach and offers customized portfolio management for clients across the country. The firm is celebrating its 10th anniversary this year and Travis has been in the investment business for nearly 20 years. Seeking Alpha (SA) sat down with Travis to discuss why he also researches the bearish side for potential long ideas, how/why he uses options and why persistence is an undervalued investing characteristic.

SA: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?

Travis: Our investment process is focused on maximizing risk-adjusted returns. We begin by trying to identify securities that trade at large discounts to intrinsic value to ensure an adequate margin of safety and create strong upside potential. When we have narrowed down our favorite opportunities, we look at how best to capitalize on them. This often means buying the equity, or perhaps the debt is the better play. It can also mean a more conservative and income-generating strategy such as cash-secured puts or covered calls. This is where the customization of the portfolio comes into play and taking into consideration client risk tolerances and investment objectives.

We do not focus on any one area of the market, but usually we are attracted to areas that are temporarily out of favor, as we tend to find more attractive investment opportunities in those areas. One of the benefits of having been in the business for a long time now is that we are constantly expanding our circle of competence to other industries and companies. Our knowledge of financial stocks is an advantage, but we have invested and had success across a broad spectrum of industries thankfully.

SA: Do you think there’s an edge from “time arbitrage” (a longer holding period)? Is this an edge that will never be competed away? Are there any specific lessons you’ve learned from holding (and intensively following) a stock for years?

Travis: I absolutely think there is time arbitrage from holding stocks over a longer period of time. Undervalued stocks are often priced cheaply because of difficult short-term conditions. It is uncomfortable to buy stocks when you know the next few quarters are likely to be disappointing, due to a challenging economic environment or whatever the case may be. I think being a truly long-term investor is tougher sale for Wall Street, and an even harder practice to employ psychologically, so I do think it is a durable competitive advantage.

Following a stock for years is enormously beneficial. You get a good feel for management and how they react to challenges and opportunities. Generally, the warts of the business emerge over the microscope of time. Sometimes, as we saw last year, stock prices will drop to truly nonsensical prices on businesses you know deeply, allowing you to bet big and with conviction. ALLY Financial (NYSE:ALLY) was a great example of that. The stock traded down from the $30’s to less than $10 due to C-19/lockdown fears, which implied losses far greater than seen during the Great Recession. I couldn’t justify the price whatsoever, which meant buying big and taking advantage of that dip. Now the stock trades in the mid $50’s, and I still wouldn’t be shocked to see a big bank buy it if they could clear the regulatory hurdles, but I no longer see the clear and obvious margin of safety and upside potential that it had before.

SA: How do you use management guidance and investor presentations in your analysis? Can you give an example?

Travis: Rarely does anyone know the business better than management, so I certainly use their guidance and investor presentations in my analysis. I don’t focus on any one quarter, but instead look at how they evolve over time. This includes investor conferences where the investment bank conducting it might target specifics areas of the business such as technology, or drug development etc. Over time the mosaic comes together. Does management deliver on their forecasts? Are they overly promotional? Is there a lot of management turnover? ALLY is a great example of a management team that has regularly beaten its forecasts and delivered on its goals, while not being overly promotional. That gives you a lot of confidence, especially when they are dealing with a recessionary environment. Other companies such as Cleveland-Cliffs (NYSE:CLF) and Assured Guaranty (NYSE:AGO) have also been very solid in how they have publicly communicated with investors. The Cliffs earnings calls are usually my favorite due to the CEO’s style and his ability to deliver on what he says.

SA: If you own a stock (and/or are thinking about buying it), do you research the bearish side? If so, how do you separate the legitimate from the not so legitimate bearish arguments and determine if it’s already priced in? Have you ever exited a long position (or not bought in the first place) after reading a persuasive bearish thesis?

Travis: I absolutely will research the bearish thesis, as I think one would be foolish not to. A great example of that was David Einhorn’s bearish case on the stock of Assured Guaranty. Most of the argument was based on innuendo and overly pessimistic projections on future losses that didn’t line up with my analysis whatsoever. I had seen current AGO management be overly conservative in its RMBS loss reserves during the financial crisis. I’d seen them accurately reserve for billions in recoveries from rep and warranty litigations following the financial crisis. Now we are seeing that the company is at least fully reserved for Puerto Rico after the latest settlements on their most troublesome exposures, which the market doesn’t seem to fully understand quite yet. When the bear case is a bunch of bluster with little merit upon a careful and deep analysis, it can make you want to back up the truck.

SA: How do you use options on an individual and/or portfolio level? Can you give an example? What are the risks with this strategy?

Travis: We use options as a tool to generate income, reduce risk, and to instill disciplined selling principles. We don’t speculate with them. For the last few years, we have invested in the common stock of CLF, usually buying on dips or selling puts on the stock. From time to time, we’ve been exercised on those puts, and we’d then sell calls way out of the money at prices that we were willing to sell the stock at. With the recent surge in steel and iron ore prices, CLF has run away from us and we’ve sold our stock, despite still loving the company and the management team. We would be willing buyers at cheaper levels though, so we’ve sold puts throughout the year and taken advantage of the relatively high premiums available. Until recently, we were getting 7-8% returns, or midteen returns annualized selling $10 puts on CLF, despite the fact the stock was trading around $20 per share. Surely, if the stock rallies to $30, we’d have done better simply buying stock, but it is a cyclical business and we are concerned with the overall market levels, and for us this is just a very attractive risk-reward opportunity. When you compare this risk-reward versus high-yield bonds for instance, I’d take my chances with selling the puts as we’d be happy to own the stock if it were to drop to those levels and retain the upside from there.

SA: What are several key lessons learned from your investing role models? Can you discuss how you applied one (or more) of them?

Travis: All of my investing role models communicate openly and honestly with their investors. Nobody can control the outcome, but you can control your process, work ethic, and the integrity at which you conduct business. We showcase that on our blog and our newsletter, and our articles such as those posted on Seeking Alpha. One lesson I’ve learned with experience though is to go your own way. Riding the coattails of other investors’ ideas, without doing your own deep dive into the company is a mistake in my estimation. By the time you hear what stocks funds that you respect are buying, the information and opportunity can often be stale, or incomplete. I respect investors such as Bill Miller that have been able to really expand their circle of competence and recover from ridicule after the tough time he experienced during the financial crisis, to becoming a star once again. Persistence is an undervalued characteristic.