According to analysts, a deep value stock is the one which is low priced in relation to the margin of safety the stock provides, to limit losses when a mistake is made. They are like any other stock traded on the exchange, but there is no hypothetical understanding of them. A section of traders on the Bombay Stock Exchange even call these stocks as ‘sleeping giants’.

Two ways in which you can identify a deep value stock.

First, what Benjamin Graham recommends for the defensive investors in his 1949 classic, that the stock price should not be more than 15 times its average earnings per share over the past three years and the overall PE of the portfolio should not be more than 13. Or second, the stock should be trading below its 10-year median PE.

Secondly stick with companies that have a long history of consistent profit growth and steady dividend payouts and the fact that not every cheap stock would turn out to be a bargain.

Public Sector banks like Oriental Bank of Commerce, which is trading at a PE of 5.6 with book value of Rs 240 for FY09, is a perfect example of a deep value stock. In a growing economy like India, banks should do well as the GDP expands.

Such stocks generally remain neglected by the stock markets investors. People know it’s a great story but still they don’t want to buy into it. For example if one saw the real estate boom in India five years back and bought into stocks like Unitech, his portfolio returns would have multiplied many fold.

Portfolio Allocation

As far as portfolio allocations are concerned, analysts feel that an investor could invest 80% in growth stocks and 20% in value stocks. In case of a pure deep value investor, experts say that typically 80% the investment of investible funds should be in these stocks and 20% of the funds should be kept aside for fixed income instruments or cash balance.

Investment Horizon

Though opinions differ on an ideal investment horizon, most analysts agree that it should not be less than a year and which could extend up to three to five years to reap big dividends. An investor needs to ask himself whether he is a speculator or an investor.

If you are a speculator then there is no chance for you to stay in deep value stocks.   If you are an investor, a time period of three to five years is what makes sense. However, if the stock does not give the required return even after holding for three years, there is something more than one‘s own understanding about the stock.

The reason why these stocks have ridiculously low valuations is that the market sometimes tends to overlook an industry. And usually these stocks are not popular with brokers.

Apart from that, analysts explain that there could be reasons such as high transaction impact costs (small caps can have transaction impact costs as high as 30-50% ) and fear of uncertain events or adverse macro environment conditions such as rise in oil and interest rates, government policies, etc.

If you have the patience and willing to invest for a longer time horizon than deep value stocks are the safest bet. When their turn comes such stocks can give stupendous returns.