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Rotten or not? MichelPireu     | Business Day Wednesday, December 5, 2018
Buying undervalued companies can be lucrative but can also expose you to deteriorating businesses - some are cheap for a reason.

The question to ask: Is it blemished or rotten to the core?

“We have always liked the analogy between shopping for fruit and value investing,” says Jacob Wolinsky at Trapeze Asset Management. “It's our job to determine whether a business has sold off because of a minor blemish, one that could be cut out with a paring knife, or whether it's rotten to the core. We are looking for opportunities where there was a short-term disappointment, industry concerns, or news flow that sparks uncertainty which unduly depresses a company's share price. And, we do find ourselves passing over businesses all the time because they might be spoiling - they aren't undervalued or are overly vulnerable, for example, to competition, cyclicality, regulation, or a single customer but these companies might have too many moving parts, too many competitors, or are too levered - financially and operationally - and therefore overly vulnerable to sudden changes in the landscape. For these reasons we find ourselves mostly passing over opportunities which are potentially high reward but equally, if not more so, high risk. The better the business, the more predictable its earnings. The more predictable the earnings, the easier it is to estimate fair value with relative confidence. Companies that trade at low valuation multiples, appearing undervalued, may provide more upside, but are less predictable and the risk of erring is substantially increased as high quality companies typically don't wonder too far from their intrinsic value. Only at the depths of bear markets, when everything's on sale, can one normally find superb companies at larger discounts. What makes undervalued companies so difficult to find is that most businesses lie somewhere between the two.”
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