My Step-by-Step Guide to Outperformance

How I find and evaluate companies to build an outperforming portfolio.

Hey All 👋

Welcome to 📉 DeepValue Capital 📈

This post is not for everyone, only serious investors.

It’s for investors who want to see exactly how I find, filter, and invest in turnaround stocks.

If that’s you, you will love this. It’s my investing framework, updated often, built to evolve with me as I refine my process over time. I repost this every year. Keep an eye out for the updated guide.

Inside, you’ll get:

• How I generate ideas no one’s talking about

• The exact filters I run every stock through

• My approach to valuation, conviction, and sizing

• How I use options (and when I don’t)

• How I manage risk without playing scared

It’s long. It’s detailed. It’s the foundation of how I invest.

Let’s get to work.

🔍Finding Companies: Where It All Starts

Before I dive into research or valuation, I need names on a list. This step isn’t about quality or conviction. It’s about gathering potential threads to pull.

Many of my ideas outside of my watchlist come from non-traditional investors. People who go deep on sectors that don’t get much airtime. I listen to podcasts, read on Substack, and watch YouTube videos. I’m looking for undercover companies no one is talking about.

If someone mentions a company I haven’t seen before, I do a quick scan:

• Is it in an industry I understand?

• Is the industry growing?

• Is a company I have never looked at?

If the answer is yes, it goes on an idea list. That’s it. No analysis yet. Just a name to come back to.

🗂 My Living Watchlist

I use Stock Unlock to track everything I’ve already looked at.

If I decided previously they would be interesting at a lower price it has a price target set. If the stock drops near that level, it automatically moves back onto my radar. And onto the idea list to look into again.

🧭 When I Go Hunting

If nothing comes up from those first two lead generation methods I turn to screeners.

I might:

• Sort by P/FCF or P/S.

• Filter for names down significantly from highs.

• Or scroll alphabetically through a sector I’m curious about.

I use Finviz and Stock Unlock to run these screeners and change them often just to find companies I haven’t looked into yet that might be interesting.

Note, these companies must pass the same filters as before.

• Is it in an industry I understand?

• Is it a company I have never looked at?

🧠 My Filtering Rules

I mentioned I only track companies in industries I understand.

That doesn’t mean I need to know the company itself yet. But I should have a basic idea of what risks the industry faces and how they make their money.

These are industries outside my circle of competence or ones I just don’t like:

• AI

• Airlines

• Banks

• Biotech

• Car Manufacturers

• Insurance

• Marine Freight

• Medical Devices

• Precious Metal Miners

• Restaurants

• Robotics

• Tobacco

• Textiles

It’s not that they’re uninvestable. I just know I’m not the right person to evaluate them. They fall outside my circle of competence or I just don’t like their business models.

I also want the industry itself growing at least at GDP-level or better.

It is hard when they have to also fight against the structural headwind of shrinkage so I avoid it.

🪙 One Pattern I Respect

A lot of the best ideas I’ve found start with broken charts.

If a stock is down 60%, 80% or more from all-time highs, that doesn’t mean it’s a buy. But it tells me the market has moved on. It tells me the story is probably broken and that’s where I often find mispricing.

I will almost always take a quick glance at their chart while looking at them and this gut check just helps establish another layer of interest.

⏱ This Happens Daily

I’m constantly gathering names. Some days that means a couple hours of searching. Other times it’s just a few quick notes after listening to a podcast or reading a write-up.

But this is always happening.

The edge doesn’t start with analysis. It starts with looking where others aren’t.

📊Filter #1: Basic Financial Fundamentals

Once they are on my list the first filter checks the financial basics:

• ROCE or ROIC: Are they making efficient use of capital?

• Solvency: Any major debt issues?

• Dilution: Are they meaninglessly diluting shareholders?

• Valuation: Is it actually “cheap” based on the metrics?

A quick note on “cheap” valuation.

A stock is not worthy of buying just because it is cheap by any given metric. It must be in a strong financial position or returning to it based on liquidity and cash generation.

A company trading at 25 times FCF might be cheap while one trading at 10 is overvalued. It depends on things like their growth, capital use, industry and many other things. Even a currently unprofitable company could be cheap if they are at the bottom of a cyclical downturn.

On that thought of unprofitable companies often this occurs when revenue and FCF have fallen. Would I move a company through that has declined in revenue and FCF? Yes, but only if I can determine at this point if it is likely due to a short term problem and get an idea that on a normalized margin level they are cheap.

You get a sense for what you are looking for the more times you do it. All to say, get to work looking! (Or let me do the work for you!)

Example: Walmart ($WMT)

• Revenue growth: ✅ 4.46% annually over 20 years

• FCF growth: ✅ 9.04% annually over 20 years

• ROIC: ✅ 15.97% average over 20 years

• Solvency: ✅ Current ratio of 0.82

• Shareholder Dilution: ✅ Shares have decreased by 2.27% per year

• Valuation: ❌ Walmart trades at 56.8x FCF, meaning a very low FCF yield (about 1.76%, not worth it for me).

So, Walmart goes on the watchlist with a target price of around $40 or 21.5x P/FCF. Which is still certainly too high, but will be worth another look at that price.

📊Filter #2: More In-Depth Financials

Next, I dive deeper into the financials. I repeat the first filter to catch anything that slipped through. Then, I look at the following:

1. How has the business performed during other down cycles?

I like to see a business that has bounced back and get a feel for how that happens. If they go into several quarters of negative FCF normally or revenue growth slows. Just so I can compare the current trough and if it is comparable to what has happened before.

2. Is there any clear downtrend in margins indicating eroding advantages or pricing power?

If I spot any worrying signs here it is very likely this goes into a permanent pass list. (Which despite the name it can come off of if we get new management that fundamentally changes the business.)

3. Are there industry pressures either good or bad I missed?

I need a deeper feel for the head or tailwinds driving this business. Are they short term or long term?

4. On a basic level how do their margins, returns on capital, and growth compare to competitors?

This will help me gauge where the company sits. I am not always looking for the top #1 or even #2 player but if they are obviously the bottom of the barrel it is not a company I want to invest in. It would go into my permanent pass list.

🤝Filter #3: The Qualitative Deep Dive

For this filter I’m reading reports, listening to earnings calls, and trying to get a feel for the company qualitatively.

• What’s their competitive advantage?

• How transparent is the management team?

• Does leadership have a track record of high shareholder returns?

• What issues is the company facing? How are they overcoming them?

• What is managements pay tied to? EPS? FCF?

This is the most time-intensive and important step.

I am looking for a transparent honest management that has incentives that are at least decently aligned with shareholders. If they have a track record of terrible promises, flowery vague language, or other things like that I will have to make a decision on if they are a permanent pass or just need a lower price.

I always keep in mind Charlie Munger when he said, “Show me the incentives, and I will show you the outcome.”

💰Filter #4: Valuation

Now that I’ve done the work, it’s time to determine what the company is actual worth.

To keep things simple I only want to estimate 4 things. Revenue growth, operating cash flow margins, CAPEX, and a reasonable FCF multiple based on company history and common sense. If the stock is obviously undervalued it will move to my last step.

Example: Cooper Standard ($CPS)

• Expected revenue by 2028: $3.7 billion

• Estimated OCF Margin: 9.25%

• CAPEX: 3% of Revenue

• Target FCF multiple: 12x

This gives a potential share price of $158 by 2028, implying 600%+ upside or a 72% CAGR from today’s price of $22.

🤔The Decision: Should I Invest?

At this point, it’s decision time. I compare the stock’s expected returns with those of my current investments, and I weigh my conviction level. Those two last comparisons let me know if it belongs in my portfolio or if I need to wait for a lower price.

Example: Comparing CPS (High Conviction, 72% CAGR)

• Stock 1: High Conviction, 40% CAGR

• Stock 2: Medium Conviction, 60% CAGR

• Stock 3: High Conviction, 80% CAGR

First, lets assume I have cash. In that situation stock 3 would be my best available option. Meaning I should not add CPS but rather should buy more of stock 3. However, if stock 3 is already at its max position size, or I need more diversification, CPS is the next best option.

If I have no cash to invest, I might sell a lower-return stock to fund the new position or add to a current one.

I will only sell that position if the other option is far better and even without it I am well diversified across 6+ industries.

My rules here are designed to be straight forward but also have barriers before I would replace any current position.

Once a position is taken and before I sell all I care about is the fundamental business performance. Not the share price. (Unless it goes low enough I would like to buy more.)

🧶Weaving in Options

Options play a key role in my portfolio, so I use them when the right opportunity comes up.

The only options I buy are long dated calls. Long dated calls help avoid the issue of timing that is common with options while giving you outsized return potential.

An important rule for adding options to my portfolio is at the time of purchase, the new position cannot move my total options positions to more than 15% of the portfolio. Options have very real risk of going to 0. I don’t want to be overexposed to that possibility.

Calls📈

When buying calls I usually look at the longest dated options available but it must be at minimum 12 months out. They must also be liquid with a fairly tight bid to ask ratio. Generally this means it needs to have volume on the day and a bid to ask with a gap less than 5% of the stocks value. These already rule out most companies.

If a stock meets that criteria then my next filter looks at implied volatility. This is something that I think comes more with time spent looking at options and their pricing. Implied volatility has a huge impact on options pricing so I look for a time when this is around average or lower to take a position.

I weigh where I think the stock will move over the next 1-3 years depending on the date of the option I prefer. I want to find options where it is almost certain the stock will create 3 times my cost in intrinsic value for the contract at expiration. I make that estimation based on my price forecasts after doing research on catalysts, fundamental drivers, etc.

Meaning if I buy a $5 option with a $50 strike, I want high confidence the stock will reach at least $65, 3x my cost above the strike.

If everything above is met and I have room in the portfolio, I take a position. Often looking to get 2, 3, 4, or even more times my money.

🧮 Position Sizing Matrix

How I decide what % of the portfolio to allocate based on conviction and expected return.

How to Read This:

• Conviction is based on how much needs to go right.

  • Low: Many unknowns or risks

  • Medium: 2–3 key things need to play out

  • High: Odds are heavily in our favor

• Return expectations are based on base-case CAGR

• The first percentage are starting weights. I may scale up if conviction holds and the stock price falls to the higher percentage which is the max position size.

🧯 Risk Management Rules

• Max positions: 12

• Max option exposure: 15% of portfolio

• Maintenance margin buffer: Must stay 40% below current holdings value

• Max leverage: Normally capped at 15% of holdings value, but scales to 35% as markets fall:

  • S&P 500 drops 10% = 20% leverage

  • 15% drop = 25%

  • 25% drop = 35%

“Markets can remain irrational longer than you can remain solvent.” - John Maynard Keynes

This quote is always in my mind as I add leverage so I consistently check to keep myself far from danger while also using it to enhance my returns.

🏁A Disciplined Approach to Outperformance

Every step in my process from screening to options plays is designed to maximize returns while lowering risk. It’s about finding companies that not only look cheap but have strong fundamentals and a clear path to growth. By staying disciplined, I avoid costly mistakes and position myself for long-term success.

This framework has helped me consistently outperform this year but remember, investing is a long game. The key is patience, conviction, and sticking in your circle of competence.

Thanks for reading!

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