Tight Times for Deep Value Investing

Scott Barbee, manager of Aegis Value fund, is having trouble finding bargains. Barbee, whose nearly nine-year-old fund has never had a down year, says things today are far different from how they were in early 2000. Then, as the bull market in large-company and technology stocks was nearing its end, he was able to find plenty of undervalued small-company stocks that investors had ignored for years. Says Barbee: "There was this old-economy, new-economy kind of thing, with a whole boatload of old-economy value stocks trading at very low multiples and Internet, telecom and media stocks trading at very high multiples." Today, by contrast, valuations are remarkably uniform across all segments of the stock market, he says.

Barbee keeps a watch-list of companies with share prices trading below book value, or net worth (essentially, a company's assets minus liabilities). When the overall market bottomed in late 2002 and early 2003, Barbee found that some 500 stocks were trading below book value (he screens for all stocks with market values of $70 million and up). By early 2004, the number had shrunk to about 100 and has stayed there ever since. "Everyone's had a chance to sift through the bathwater," Barbee says. As for the remaining bargain-bin merchandise, the average discounts are not as large as they once had been, and the quality of the typical company is not as strong.

Barbee prefers small-company stocks that he thinks can rise 80% to 100% over the next three to four years. When he finds potential candidates, Barbee, working with two analysts, scours balance sheets to uncover undervalued assets or overstated liabilities. At last report, the fund's biggest holdings were PMA Capital Corp. Class A, Audiovox, Superior Industries International, CF Industries Holdings and Spansion.

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Barbee doesn't mind sitting tight in a dry market. The $430-million fund currently has about 30% of assets in cash. Barbee thinks stocks may be vulnerable to a selloff because companies may not be able to raise prices fast enough to offset higher energy costs, resulting in weaker profits than analysts are expecting. If a correction leads to more bargains, all that cash will come in handy. "We had one of our best years in 2002 because when the market sank we were able to invest our cash reserves," he says.

Indeed, 2002 may have been Aegis Value's most glorious year ever. The fund returned a bit more than 1%, making it one of the few stock funds to finish the year in the black (Standard && Poor's 500-stock index lost 22% in '02, and the Russell 2002 Value Index dropped 11%). Since its 1998 inception through June 20, the fund returned 16% annualized, compared with 8% annualized for the Russell 2000 Value Index and 5% annualized for the S&P 500.

Aegis (symbol AVALX; 800-528-3780) requires a $10,000 initial minimum investment and charges 1.37% per year for expenses.