Investing at the point of maximum pessimism

One of the investing principles adhered to by those with an eye firmly fixed on value is searching for bargains among the most depressed industries or areas of the world.  (In everyday terms, this equates to waiting until a really good strawberry season has occurred and prices have dropped to $1 lb.)  Peter Cundill, the Canadian value investor who achieved 15%+ per annum returns for 30+ years, made it a point to visit the worst performing stock market in the world each year in search of bargains. 

 Until this year, one of the world’s worst performing markets was Brazil.  When I began searching for bargains in this market last year, I was presented with a triple whammy.  In particular, three things converged to provide a suitable return – the economy in Brazil was in recession, the Brazilian Real had depreciated against the U.S. dollar by as much as 36% and steel prices were depressed on a global basis.  All three contributed to the declining price of Gerdau SA (NYSE ADR: GGB), a leading producer of long steel and one of the largest suppliers of specialty steel in the world. 

At the time of my analysis, this family owned company was priced at 10% of book value and at one point was priced nearly equal to the amount of cash held in reserves, which provided an ample margin of safety for investment.  The business had a long term track record of profitability and managements goals were financially aligned with their compensation structure (management is required to have a portion of their compensation in stock).  Fast forward a year later and the public’s valuation of Gerdau has increased, which tends to happen over time when things are underpriced.   In this case, the market’s underpricing resulted in a 67% return on investment as of this morning when I reduced our positions by 50%.

Here is a recent WSJ article about the 2016 rebound in Brazil