An Unsentimental Approach to Finding Value

A key component of contrarian, value investing is the conviction that attractive valuations, strong management and solid balance sheets eventually win out over short–term sentiment. Without this belief, temptation to give in to the whims of the market would be strong. A steadfast approach has been particularly important during the environment of the past five years.

As shown in the chart below, stocks with the most bullish sentiment—as measured by analyst ratings—had a clear performance advantage during the most recent one–, three–, and five–year time frames.

While the recent trend is frustrating for value investors, we believe it has created a powerful opportunity to uncover companies with upside potential that the street has ignored or is misinterpreting. Independent Bank Corp. (INDB) represents this type of opportunity.

We initiated a position in the bank holding company in 2011 when it had only a hold rating by the street. In spite of this weak sentiment, its valuations were compelling. At approximately 1.8x tangible book value, the company was trading at an 18% discount to its five–year historical average of 2.2x. We also believed Independent Bank could continue to build on its success in reducing debt—a belief proved accurate as debt levels have come down 27% over the past three years. The company has grown its balance sheet through selective tactical mergers and acquisitions and has increased returns on tangible assets and equity.

Our willingness to look beyond the consensus of sell–side analysts was rewarded as shares are up 80%—including dividends—since we first bought a stake. The stock outpaced its industry group by approximately 1000 basis points during the period.

Conversely, staying true to our process has prevented us from buying names where we believed inflated valuations created unwarranted downside risk. PTC Therapeutics Inc. (PTCT), a member of the Russell 2000® Value Index, has enjoyed strong sentiment during the past 18 months with an average of 90% of analysts covering it rating it a buy. During the period, investors have piled into Health Care names and biotechnology companies in the Index have particularly benefited. Shares of the company are up 76.10% over the past 12 months— in line with the 78.99% return for the industry as a whole in the Index.

While analysts are enamored with the stock, a look at the underlying valuations has steered us elsewhere. The company trades at 5.48x book value and has reported negative earnings for each of the past two years. In its most recent quarterly release, it announced a loss of -$1.14 per share. While we do not have an opinion on what the future holds for PTC Therapeutics, it wouldn’t be in keeping with our philosophy or process to speculate in the stock.

It is difficult to predict when the tide will turn in favor of valuations over sentiment, and, fortunately for those with long–term perspective, this question does not need to be answered. As fundamental, bottom–up investors, we continue to believe that a focus on valuations, balance sheets, and management will be the most prudent path toward long–term positive returns.

Disclosure:

Past performance does not guarantee future results.

As of June 30, 2015, Heartland Advisors on behalf of its clients held approximately 1.90%, and 0.00% of the total shares outstanding of Independent Bank Corp. and PTC Therapeutics, Inc., respectively. Statements regarding securities are not recommendations to buy or sell. Portfolio holdings are subject to change. Current and future holdings are subject to risk.

The statements and opinions expressed in this article are those of the presenter(s). Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. The specific securities discussed above, which are intended to illustrate the advisor’s investment style, do not represent all of the securities purchased, sold, or recommended by the advisor for client accounts, and the reader should not assume that an investment in these securities was or would be profitable in the future. Any forecasts may not prove to be true. Certain security valuations and forward estimates are based on Heartland Advisors’ calculations. Economic predictions are based on estimates and are subject to change.

Investing involves risk, including the potential loss of principal. There is no guarantee that a particular investment strategy will be successful.

Industry and sector classifications for are generally determined by referencing the Global Industry Classification Standard codes (GICS) developed by Standard & Poor’s and Morgan Stanley Capital International.

Definitions: Basis Point (bps): is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument. Price/Book Ratio: of a company is calculated by dividing the market price of its stock by the company's per-share book value (the sum of all assets, minus liabilities, divided by shares outstanding). Price/Tangible Book Ratio: of a company is calculated by dividing the market price of its stock by the company's per-share tangible book value (the sum of all assets, minus liabilities and intangible assets, divided by shares outstanding). Russell 2000® Value Index: measures the performance of those Russell 2000® companies with lower price-to-book ratios and lower forecasted growth characteristics. All indices are unmanaged. It is not possible to invest directly in an index.

Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Frank Russell Investment Group.

CFA is a trademark owned by the CFA Institute.

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