By Dan Ferris in the Extreme Value Weekly Update:

Your letter is called “Extreme Value”. I don’t consider [blue chip stocks] to be generators of great value. How can they be. Extreme value occurs in the early stages of a stock’s growth. It’s a mathematical law. How can [these stocks] ever grow exponentially? – Paid-up subscriber H.M.

Ferris comment: I’m not sure what you’re describing, but it isn’t value investing. Nor is it Extreme Value investing. A company’s market cap has nothing to do with how much value it creates. Nor does value investing have anything to do with a focus on early-stage growth companies or exponential growth. Early-stage companies are risky bets and difficult to value. It’s highly unlikely any such company will never make its way into these pages.

Extreme Value means getting the best possible assets and businesses at the cheapest possible prices. When you’re buying [the No. 1 Extreme Value stock’s] cash and securities at a discount and getting its massive upside and the services of its stellar management free of charge, you’re doing Extreme Value investing. When you buy [the No. 2 Extreme Value stock], the most cash-generative business in the world, at 10 times free cash flow, you’re doing Extreme Value investing. When you recognize the substantial value created by dominating 80% of the global market for semiconductors and understand Intel sets the pace for innovation in its industry, paying 13 times free cash flow, that’s Extreme Value investing. When you buy a business like IMS Health, which has a one-of-a-kind database that’s been 50 years in the making, and now tracks 90% of the prescription drug transactions in the U.S., and you see it trading for less than five times free cash flow, you’re doing Extreme Value investing.

If you want a quick gauge of how much value a business generates, look at return on capital. World Dominator stocks generate high returns on capital. [Our No. 2 stock] requires little capital and generates more cash than perhaps any business on Earth. [Another of our World Dominators] is in a capital-intensive commodity business, and management still achieves high returns on capital. It’s impossible for the business to not generate huge amounts of value.

When the greatest businesses in the world trade at deep discounts to intrinsic value, the situation is the opposite of what you’re implying. Such stocks bought at such prices contain the potential to generate more risk-adjusted value to shareholders than any other stocks in the world. World Dominators are the most valuable businesses in the world. When you can get the most valuable businesses in the world for substantially less than they’re worth, it generates tremendous value for you as a shareholder.

You should read Joel Greenblatt’s book, The Little Book That Beats The Market. It’s a great way to learn what value investing is about: getting good businesses at cheap prices.