Hunting for good investment prospects

Selecting investments

In selecting investments, value investors choose those shown by valuation analysis to be the cheapest.

Valuation analysis takes account of all relevant business factors, including:

• financial strength,
• relative business growth, and
• steadiness of earnings.

Once a valuation estimate is made, no additional consideration should be given to such factors.

Good investment prospects

Hunting for good investment prospects entails assessing only the group of companies most likely to win the valuation contest.

Among these businesses are those ablest to deploy additional capital at high rates of return compared to capital costs.

Businesses to avoid are those that must employ additional capital at low rates of return compared to capital costs.

The former population is far smaller than the latter.

To minimize error risk: margin of safety

Applying the valuation equation to this universe of companies is difficult and poses substantial risk of error.

To minimize error risk, value investing calls for a key disciplining attitude: margin of saftety.

It prescribes never paying a price approximately equal to ( or greater than) the value estimate you've made. If the investor is wrong, he will lose.

If the investor insists on paying only a fraction of any value estimate she makes, even if she is wrong, she may avoid future losses and certainly will reduce them.


Also read:
Valuation
1. Value Measurements
2. Hunting for good investment prospects
3. What data most reliably indicate value