Rationale of Value Investing:
1. You will have a specific value framework to help you make investment decisions.
2. You will know how to find the balance between price and value, and how to "buy right."
3. You will know how to identify events that move stock prices.
4. You will be able to generate your own value investment targets and build your own portfolio.
Goal of the Value Investor:
Good Business + Excellent Price = Adequate Return over Time
Emotional Discipline:
With an established framework, value investors are more likely to avoid getting caught up with the moods of the market or their own emotional feelings of the day.
Charateristics of Value Investors:
1. They exude emotional discipline.
2. They possess a robust framework for making investment decisions.
3. They apply original research and independent thinking.
The Seven Fundamental Beliefs:
Belief No. 1: The world is not coming to an end, despite how the stock market is reacting.
Belief No. 2: Investors will always be driven by fear and greed, and the overall market and stocks will react accordingly. This volatility is simply the cost of doing business.
Belief No. 3: Inflation is the only true enemy. Trying to predict economic variables and the direction of the market or the economy is a waste of time - focus on businesses and their values, and remember Belief #1.
Belief No. 4: Good ideas are hard to find, but there are always good ideas out there, even in bear markets.
Belief No. 5: The primary purpose of a publicly traded company is to convert all of the company's available resources into shareholder value. As shareholders, your job is to make sure that this happens.
Belief No. 6: Ninety percent of successful investing is buying right. Selling at the optimal price is the hard part. As a result, value investors tend to buy early and sell early. [Buying early allows the investor to use dollar cost averaging. Dollar cost averaging is buying more shares of a particular company as the share price trades lower in the market place.]
Belief No. 7: Volatility is not risk; it is opportunity. Real risk is an and permanent change in the intrinsic value of the company.
Five key questions in considering investment opportunities:
1. Is this a good business run by smart people?
This may include items such as quality of earnings, product lines, market sizes, management teams, and the sustainability of competitive positioning within the industry.
2. What is this company worth?
Value investors perform fair value assessments that allow them to establish a range of prices that would determine the fair value of the company, based on measures such as normalized free cash flow, break-up , takeout, and/or asset values. Exit valuation assessment provides a rational "fair value" target price, and indicates the upside opportunity from the current stock price.
3. How attractive is the price for this company, and what should I pay for it?
Price assessment allows the individual to understand fully the price at which the stock market is currently valuing the company. In this analysis, the investor takes several factors into account by essentially answering the question. Why is the company afforded its current low valuation? For example, a company with an attractive valuation at first glance may not prove to be so appealing after a proper assessment of its accounting strategy or its competitive position relative to its peers.
4. How realistic is the most effective catalyst?
Catalyst identification and effectiveness bridges the gap between the current asking price and what value investors think the company is worth based on their exit valution assessment. The key here lies in making sure that the catalyst identified to "unlock" value in the company is very likely to occur. Potential effective catalysts may include the breakup of the company, a divestiture, new management, or an ongoing internal catalyst, such as a company's culture.
5. What is my margin of safety at my purchase price?
Buying shares with a margin of safety is essentially owning shares cheap enough that the price paid is heavily supported by the underlying economics of the business, asset values, and cash on the balance sheet. If a company's stock trades below this "margin of safety" price level for a length of time, it would be reasonable to believe that the company is more likely to be sold to a strategic or financial buyer, broken up, or liquidated to realize its true intrinsic value - thus making such shares safer to own.
Example Valuation Approach:
1. Sum of parts valuation (using three different multiples EV/EBITDA, EV/FCF, and PE).
2. Historical valuation (using the same multiples to see how the market valued the company historically).
3. Transaction deal basis (comparison with similar deals using EV to Cash Flow and EV to Revenue).
Take an average to give an idea of Fair Value. The need is then to establish a Purchase Price at a discount to Fair Value and with a margin of safety. For example, 5.5 times Enterprise Value to pre-tax and interest cash flow could be used.
http://www.docstoc.com/docs/7984050/Investment-Strategies (Pg 54 to Pg 56)
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