Benjamin Graham is known as the Father of Value Investing. He is one of the greatest American investors, who had his own unique ways of making money. The forte of Ben Graham was to make money for himself and his clients, without taking huge risks. He was the one with a low risk appetite but a huge appetite for profits, and he made it work with his own strategies. He created many principles for investing safely and successfully.
One of the approaches of Ben Graham was the Bargain Bin Investing or the Cigar-Butt Investing. This strategy looks inelegant but is rather profitable. The bargain bin strategy involves buying the stock of the company which is not doing very well financially, yet has some value in it. The company is ideally a compromise between price and quality. Many investors end up paying huge money for high quality. However, Benjamin Graham possessed the unique ability and sensibility to pick up stocks not very expensive, yet with some value that can be worked on.
In the bargain bin investing strategy, the stocks trading at discount to their asset values are bought and traded. More often than not, such bargain stocks are able to give strong investment returns.
The importance and significance of Bargain-Bin Investing has been emphasised on in the book “The Manual of Ideas: The Proven Framework for Finding the Best Value Investments” by John Mihaljevic. John states:
“Those of us who liked to dig through the bargain bins of CD stores—back when stores like the Virgin Megastore in Manhattan ’s Union Square still existed—may identify a few unique features of bargain bins. They tended to be somewhat hidden within the stores, certainly getting less attention than the latest top 10 selections. Instead of being arrayed on easy-to-browse shelves, the CDs were essentially tossed into a large bucket, putting the onus on the shopper to discern between the mediocre, the bad, and the worse—in the hope of finding the occasional good. The bargain CDs came with a no-return policy, putting all the risk squarely on the shopper. Finally, they came with considerably less opportunity to meet someone cool of the opposite sex while browsing, unless one was looking for a date who wouldn’t mind being taken to a meal at McDonald ’s. You see, it took a certain type of person to enjoy bargain bin shopping—and it is no different with Graham style equity investing.
Here, John compares the bargain bins at the retail stores with the bargain bins of investing. The retail stores have the bargain bins that contain hidden treasures which get revealed after careful and persistent search. Similarly, there are certain bargain stocks that contain hidden values, which can be uncovered and tapped into with careful analysis.
Value investor Ethan Berg describes his bargain-hunting sensibility as follows: “I had observed in major items I purchased in my consumer life that with a little digging there regularly were anomalies on how things were priced, or more accurately, mis priced. My Red Sox season tickets were $20 a seat but with the same view as seats two rows away at $65 a seat and across an eight-foot aisle that were $45 a seat. I purchased my car used, at one-fourth of its original cost, even though it still had what I estimated to be approximately 85 percent of its useful life remaining.”
On a similar note, Ethan Berg also emphasises that bargain deals are not always poor quality. There are times when by slightly increasing the quality, the price is heavily increased for products. This is where bargain bin investing comes into play. The stocks that are available at low prices need not be of poor value. Their value may be slightly lower than other comparable stocks, but they can still give good returns, especially considering the low cost of investment.
Bargain hunting is something most us embrace in principle, but true bargain hunters are few and far between. On the line that represents the trade-off between quality and price, most investors find themselves creeping toward quality, accepting a higher price in return for greater certainty and peace of mind. There is nothing wrong with such a transformation. After all, Warren Buffett has famously undergone the same shift in his investment approach. That said, Buffett has hinted that the shift has been at least partly motivated by the mushrooming of his investable assets.
In his personal portfolio, Buffett has ventured into Graham style bargains long after Berkshire started focusing on high-quality franchise businesses. Several years ago, Buffett was reported to have invested some of his personal portfolio into South Korean net nets—companies trading for less than their current assets minus total liabilities. The investment approach of Zeke Ashton, managing partner of Centaur Capital Partners, has evolved similarly. “We very much prefer our ideas to take the form of high quality businesses with excellent management that can grow value over the longer term, but we will buy mediocre assets if the price is right.”
Therefore, the bargain-bin of investing technique is different from the usual techniques. It may sound like scraping the dirt, but it is essentially not. The strategy has been efficiently used by many successful investors and has a strong profit potential, with low risk profile.