Where to find bargains in the dark corners of the stock market

Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

Warren Buffett bought a basket of cheap South Korean stocks about a decade ago. In doing so, he put the country on the map for North American value investors and a few of them have followed his lead.

Keith Smith is one such investor. He lives in Rochester, N.Y., and by day is a mild-mannered managing director at Empire Valuation Consultants, which specializes in business and financial valuation. But at night, he hunts for bargains in the dark corners of the stock market.

While Mr. Smith's day job gives him the tools needed to size up a company, beating the market isn't a simple matter. Yet, it's something he has excelled at over the years.

Mr. Smith figures his portfolio has grown by an average of 35 per cent a year over the decade ending Dec. 31, 2013. While it hasn't fared quite as well so far this year, his portfolio has climbed 14 per cent during the first nine months of 2014.

His remarkable record is the result of years spent roaming the market's back alleys for cheap value stocks. To track them down, he looks for firms trading at very low EV/EBITDA ratios.

You'll remember that EV, or enterprise value, reflects the market value of a business, including both its equity and net debt. EBITDA, or earnings before interest, taxes, depreciation and amortization, is a rough measure of a firm's operational profitability, which is independent of its capital structure. You can think of the EV/EBITDA ratio as being roughly analogous to the more popular price-to-earnings ratio.

This column featured one of Mr. Smith's low-EV/EBITDA stocks last November when he recommended General Communication Inc.. The integrated telecom stock based in Alaska has advanced 13 per cent since then and it remains one of his favourites.

Moving across the Pacific Ocean, Mr. Smith is very fond of three South Korean preferred stocks that he owns. Each preferred stock trades at a big discount to its common stock due to a lack of voting rights and liquidity. On the other hand, they pay bigger dividends and, unlike North American preferreds, participate in their companies' economic growth.

The first two firms Mr. Smith favours own large stock and real estate portfolios that could, in principle, be sold off without affecting their businesses. As a result, investors get their core operations for next to nothing.

Lotte Chilsung Beverage Co. Ltd. represents a good example. It's one of the largest beverage makers in the country with products ranging from soft drinks to a variety of liquors. If the preferred shareholders could sell off the firm's large securities and real estate holdings, Mr. Smith figures they'd get its operating business for less than one times EBITDA.

Taeyoung Engineering & Construction Co. Ltd. runs a large construction business and has leisure and broadcasting operations on the side. It also owns a big portfolio of stocks and real estate. Once it is factored out, Mr. Smith figures the preferred stock trades for about 0.9 times EBITDA.

Korea Investment Holdings Co. Ltd. is one of the largest brokerages in the country and has a sizable value-oriented asset management firm among its many subsidiaries. Mr. Smith thinks its preferred shares trade for about 50 per cent of what he estimates the company is worth.

While these companies trade at low prices, it is important to keep in mind that they aren't likely to sell their non-core assets any time soon. As a result, it's unwise to expect big gains from them overnight.

Nonetheless, as Mr. Smith's track record has shown, buying bargain stocks has been a profitable endeavour in the past.

Adventuresome value hunters who don't mind investing in foreign lands and aren't afraid of its northern neighbour should take a look at what South Korea has to offer. Getting direct access to the South Korean market can be difficult for Canadians, but investors can easily buy the iShares MSCI South Korea Capped ETF. They might also opt for the large firms that trade in the U.S., such as POSCO, which is one of Warren Buffett's favourites.