1. Prices and Intrinsic Values Regularly Diverge
- If prices are fluctuating a lot and you think fundamental values are stable and the evidence is in favor of that too. Then Prices are going to diverge regularly from fundamental value.
2. You Can Measure Some Fundamental Values
The second assumption is more problematical: it is that you can identify which stocks are trading above or below their fundamental values.
- That means fundamental values have to be measurable and that is by no means always the case especially by you.
- To give you a simple example of that, I sit on panels where we advise the managers of charitable trusts who invest money in the United States and invariably it is me and a bunch of people who sell money management services,and they all talk about how good they are at evaluating or estimating the value of stocks like Microsoft. And this was back when Microsoft was trading at 70 times earnings when it was at $110 a share. This was in the year 2000.And I thought, thank God I am not that type of Jackass who has to pretend to be able to do that.
- Because the truth of the matter is that the value of Microsoft doesn’t depend upon what happens in the next ten years because the dividend return you will get will be at most 15% of the value of the stock.
- So what you are pretending what you can do is being able to forecast what MSFT will look like in the year 2010 and from then on. If you do that, lots of luck. So it is not clear, but we are going to talk about cases where it is true and where you can do it.
Price and Values will Converge
Then another article of faith is ultimately the fundamental values will out. If you hold it long enough, you will get superior returns and the market prices of these stocks will return, and there is some evidence that is the case.
- When you try to put this into practice, what it means is first of all, because most, not all, will not be strikingly under or overvalued if you are thinking of going short.
- You have to look Intelligently for things that you are going to value.
- Then when you estimate values, you have to be rigorous about knowing what you know.
Not all values are measurable (as in the Microsoft case.)
- And much more importantly as Warren Buffett has recently proved—though he is the most successful investor in history, but as he has recently proved with respect to silver and the value of the dollar--not everybody is an expert in everything.
- You are not going to be good at valuing everything.
- You have to concentrate on what your own particular circle of competence is.
3. Search for Opportunities
The third idea is that you look Intelligently for opportunities.
- You are rigorous about valuing those opportunities and then you have to be patient.
- And Buffett tells a little story where he says, ― Investing is not like baseball where you have to swing at every pitch. You don’t have to swing, they can throw as many pitches as you want, and you still don’t have to swing.
- Value investing implies concentration not diversification.
- Because you can be patient, you want to wait for your pitch.
- That is the good news.
The bad news is that any professional investor knows--they run up the score whether you swing or not.
- Because you are being compared to indices.
- Because you have to have some reasonable strategy for what you are going to do when there is no obvious opportunity in these two categories.
Edited by John Chew at Aldridge56@aol.com studying/teaching/investing Page 7