What is DEEP? (Pros, Cons, and Strategies)

In the quest for building a robust investment portfolio, investors are increasingly turning to thematic ETFs that aim to tap into specific market strategies. Among them is the Roundhill Acquirers Deep Value ETF (DEEP), designed to offer exposure to deeply undervalued U.S. small-cap stocks. If you are looking for potential high returns from undervalued securities, DEEP might be worth considering. Today, we'll delve into what DEEP is, its pros and cons, and strategic considerations for investing in it.

What is DEEP?

The Roundhill Acquirers Deep Value ETF, known by its ticker symbol DEEP, is an ETF that seeks to provide capital appreciation by investing in U.S. small-cap stocks considered to be deeply undervalued. It is managed by the Roundhill Investments firm and follows a distinctive, value-focused investment strategy.

Key Features of DEEP

• Focus on U.S. Small-cap Stocks: Targets companies with smaller market capitalizations, aiming to benefit from their growth potential.
• Value-oriented Approach: Invests in stocks that are believed to be significantly undervalued based on financial metrics.
• Acquirers Multiple: Uses the Acquirers Multiple, a valuation metric popularized by Tobias Carlisle, to select stocks. This measure assesses the value of a company by comparing enterprise value (EV) to operating earnings (EBIT).

The selection process also includes rigorous financial analysis, looking at factors like operating efficiency, balance sheet strength, and potential for capital appreciation.

DEEP Composition

DEEP is composed of smaller, lesser-known companies that typically fly under the radar of most large-cap benchmarks. Its diversified composition includes a higher proportion of industrial, financial, and consumer discretionary stocks, reflecting the economic sectors where undervaluation frequently occurs.

Unlike conventional ETFs that focus on large, well-established companies, DEEP leans towards undervalued small-caps, offering a unique blend of growth potential and value.

Pros of DEEP

Potential for High Returns

Small-cap value stocks historically offer higher returns compared to their large-cap counterparts. DEEP focuses on the most undervalued small-cap stocks, providing the potential for substantial upside as these companies realize their intrinsic value.

Diversification Benefits

Adding DEEP to your portfolio can enhance diversification, as it targets different economic sectors and styles compared to large-cap or growth-oriented ETFs. This can be advantageous during economic cycles where large-cap and growth stocks may underperform.

Value-focused Strategy

The value investing strategy employed by DEEP involves selecting stocks that are trading below their intrinsic value. This approach can lead to significant market-beating returns, especially in sectors or periods where growth stocks underperform.

Cons of DEEP

High Volatility

Small-cap stocks are inherently more volatile than large-cap stocks. DEEP's focus on small-cap value stocks can make it susceptible to higher price fluctuations, particularly during market downturns.

Lower Liquidity

With its focus on smaller companies, DEEP can sometimes experience lower liquidity, leading to larger bid-ask spreads and potential difficulties in executing large trades swiftly.

Extended Time Horizon

Value investments often take longer to realize their potential. Investors in DEEP may need to be patient and willing to hold their positions for extended periods to see appreciable gains.

DEEP Investment Strategies

DEEP isn’t suitable for every investor, particularly those looking for quick gains or low-risk investments. However, it offers unique opportunities for those who understand and are ready to leverage its deep value approach.

Long-term Investment Strategy

Given its focus on deeply undervalued small-cap stocks, DEEP is best suited for a long-term investment horizon. Staying invested for five years or more can allow enough time for undervalued stocks to attain their intrinsic value, rewarding patient investors.

Investing consistently and periodically, regardless of market conditions, can also help smooth out the volatility and capitalize on dollar-cost averaging benefits.

Diversified Portfolio Inclusion

For balanced portfolio construction, consider pairing DEEP with more stable, large-cap ETFs or bonds. DEEP can serve as the aggressive growth component of a diversified portfolio, which helps manage overall risk while seeking higher returns.

Focus on Rebalancing

Regular rebalancing of your portfolio can help maintain your desired risk level and take advantage of periodic undervaluations. Given DEEP's volatility, setting a fixed schedule for rebalancing (e.g., quarterly or annually) can help lock in gains and keep your portfolio aligned with your long-term objectives.

Deep Value Philosophy

If you’re a believer in the principles of value investing, DEEP should fit well within your investment philosophy. Learning more about the Acquirers Multiple and other tools used in stock selection can also enhance your understanding and conviction in this strategy.

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Investors considering DEEP should be prepared for volatility and have a long-term perspective to fully capitalize on its value-oriented strategy. As always, doing your due diligence and consulting with financial advisors will ensure that this ETF aligns with your overall investment goals and risk tolerance.