Valuation cheat sheet. What are some of your favourite metrics?

 

Valuation Cheat Sheet

What are some of your favourite metrics?

1.  How to think about valuation

All intelligent investing is value investing:  you try to buy stocks for less than what they're worth.

Here are some valuation ratios you can use:

P/E ratio:  stock price / earnings per share

EY (Earnings yield):  earnings per share / stock price

P/B ratio:  stock price / book value

PEG ratio:  P/E ratio / yearly EPS growth

FCF yield:  free cash flow per share / stock price

2.  Always buy stocks at a discount

When you go to the mall, you like to buy your favourite products on sale.

The same goes for stocks.  You want to buy a stock at its cheapest possible price and valuation.

The beautiful thing about the stock market is that Mr. Market often acts as a Manic-Depressive.  You can use this volatility to your advantage by buying when there's blood running through the streets.

3.  Short term versus long term

Over a one-year period, most stock price fluctuations are driven by changes in valuation. 

versus 

In the long run, stock prices are driven by the evolution of the intrinsic value of a company.

This means that in the short term the valuation you pay for a company is very important while in the long term the rate at which a company can grow its earnings per share is the crucial factor.

The best investors have a process. Masters of the Market: featuring Alex Green

0.00  Intro

2.14  What did you learn from your career

6.54  Investing is a long game

9.41  The best investors have a process

12.45 Smart money in hedge funds

14.18 Is Wall Street trustworthy

18,13  How to deal with fear

23.30  How to pick stocks

28.39  How to judge management

30.14  How to build a portfolio

34.02  Do dividends matter

37.05  What are we missing

39.13  Option oriented ETFs

41.40  Trends investors are overlooked

48.15  Small Cap Stocks

51.29  Biggest Mistakes

56.14  My Biggest Mistake

57.54  Top 3 Positions

Behavioural Finance: We are hardwired to be lousy investors.

1.  We are hardwired from birth to be lousy investors.

Our survival instincts make us fear loss much more than we enjoy gain.  We run from danger first and ask questions later.  We panic out of our investments when things look bleakest - we are just trying to survive!  We have a herd mentality that makes us feel more comfortable staying with the pack.  So buying high when everyone else is buying and selling low when everyone else is selling comes quite naturally - it just makes us feel better!

We use our primitive instincts to make quick decisions based on limited data and we weight most heavily what has just happened.  We run from managers who performed poorly most recently and into the arms of last year's winners - that just seems like the right thing to do!  We all think we are above average!  We consistently overestimate our ability to pick good stocks or to find above-average managers.  It is also this outsized ego that likely gives us the confidence to keep trading too much.  We keep making the same investing mistakes over and over - we just figure this time we will get it right!

We are busy surviving, herding, fixating on what just happened and being overconfident!  Maybe it helps explain why Mr. Market acts crazy at times.

2.  So, how do we deal with all these primitive emotions and lousy investing instincts?  

The answer is really quite simple:  we don't!

Let's admit that we will probably keep making the same investing mistakes no matter how many books on behavioural investing we read.

3.  How to invest in the stock market?

Traditionally, stocks have provided high returns and have been a mainstay of most investors’ portfolios. Since a share of stock merely represents an ownership interest in an actual business, owning a portfolio of stocks just means we’re entitled to a share in the future income of all those businesses. If we can buy good businesses that grow over time and we can buy them at bargain prices, this should continue to be a good way to invest a portion of our savings over the long term. Following a similar strategy with international stocks (companies based outside of the United States) for some of our savings would also seem to make sense (in this way, we could own businesses whose profits might not be as dependent on the U.S. economy or the U.S. currency)

4.  These words of wisdom from Benjamin Graham

In an interview shortly before he passed away, Graham provided us with these words of wisdom:

The main point is to have the right general principles and the character to stick to them.… The thing that I have been emphasizing in my own work for the last few years has been the group approach.  To try to buy groups of stocks that meet some simple criterion for being undervalued—regardless of the industry and with very little attention to the individual company.… Imagine—there seems to be practically a foolproof way of getting good results out of common stock investment with a minimum of work. It seems too good to be true. But all I can tell you after 60 years of experience, it seems to stand up under any of the tests that I would make up.

That interview took place thirty-five years ago. Yet we still have an opportunity to benefit from Graham’s sage advice today.

I wish you all—the patience to succeed and the time to enjoy it. Good luck.

Book:  Joel Greenblatt:  The Big Secret for the Small Investor (2001)

Invest with discipline. Superior returns in the long run.

 Value investing rests on three key characteristics of financial markets:

1.  The prices of financial securities are subject to significant and capricious movements.

2.  Despite these gyrations in the market prices of financial assets, many of these assets do have underlying or fundamental economic values that are relatively stable and that can be measured with reasonable accuracy by a diligent and disciplined investor.

3.  A strategy of buying securities only when their market prices are significantly below the calculated intrinsic value will produce superior returns in the long run.

Think of this formula as the master recipe of Graham and Dodd value investing:

1. Selecting securities for valuation;
2. Estimating their fundamental values;
3. Calculating the appropriate margin of safety required for each security;
4. Deciding how much of each security to buy, which encompasses the construction of a portfolio and includes a choice about the amount of diversification the investors desires;
5. Deciding when to sell securities.

These are not trivial decisions.  To search for securities selling below their intrinsic value is one thing, to find them quite another.

An Simple Introduction to Value Investing

Knowledgeable investing can impact significantly on your life:  

• it can provide for a comfortable retirement, 
• send your children to college and 
• provide the financial freedom to indulge all sorts of fantasies.

Grocery shopping

Think of the search for value stocks like grocery shopping for the highest quality goods at the best possible price.  Understanding the philosophy of value investing, you learn to stock the shelves of your value store (portfolio of stocks) with the highest quality, lowest cost merchandise (companies) you can find.


More people owns stocks today than at any time in the past.  Stock markets around the world have grown as more people embrace the benefits of capitalism to increase their wealth.  Yet how many people have taken the time to understand what investing is all about?  No very many.




Making knowledgeable investment decisions can have a significant impact on your life.

Sensible investing, which can be found in the art and science of the tenets of value investing, is not rocket science.  It merely requires understanding a few sound principles that anyone with an average IQ can master.''

Value investing has been around as an investment philosophy since early 1930s.  The principles of value investing were first articulated in 1934 when Benjamin Graham, a professor of investments at Columbia Business School, wrote a book titled Security Analysis.  This approach to investing is easy to understand, has greater appeal to common sense, and has produced superior investment results for more years than any competing investment strategy.




Value investing is a set of principles that form a philosophy of investing.

It provides guidelines that can point you in the direction of good stocks, and just as importantly, steer you away from bad stocks.  Value investing brings to the field a model by which you can evaluate an investment opportunity or an investment manager.  Value investing provides a standard by which other investment strategies can be measured.



Why value investing? 

Because it has worked since anyone began tracking returns.  A mountain of evidence confirms that the principles of value investing have provided market-beating returns over long periods.  And it is easy to do.

Few investors and few professional money managers subscribe to the principles of value investing.  By some estimates, only 5% to 10% of professional money managers adhere to those principles.

Benjamin Graham, Walter Schloss and Warren Buffett are committed value investors.  Learn from their histories.

You need to invest but you don't need to be a genius to do it well.

Be patient. Patience is sometimes the hardest part of using the value approach.

The patient exercise of value investing principles works and works well.

Value investing requires more effort than brains, and a lot of patience.

Over time, investors should continue to be rewarded for buying stocks on the cheap.

Through the years, there have been changes in the methods of finding value stocks and in the criteria that define value.



Changes in the method of finding value stocks and trading

In Ben Graham's time, the search for undervalued stocks meant poring through the Moody's and Standard & Poor's tomes for stocks that fit the value criteria.  Now, you can accomplish this with the click of a mouse.  You can access almost all the data off your Bloomberg terminals.  The 10k reports or annual shareholder letters are all right there on the Internet for you to access for stocks all over the world.

Trading has changed as well.  For the most part, trading is now done electronically with no effort at all.  You can trade stocks in New York, Tokyo or London just as easily as you can in your own country.


Criteria that define value has changed over time

Just as the access to information and the methods of trading stocks have changed in the past two decades, so have the criteria for value changed.


1.  Net current assets
In 1969, the investors were looking through the Standard & Poor's monthly stock guide for stocks selling below net current assets.  This was the primary source of cheap stocks in those days.  The method had been pioneered by Graham and was very successful.  Generally, they were buying stocks that sold for less than their liquidation value.  Back then, manufacturing companies dominated the US economy.


2.  Earnings
As the US economy grew in the 1960s, 1970s, and 1980s, it began to move away from the heavy industrial manufacturing companies such as steel and textiles.  Consumer product companies n service companies became more a part of the landscape.   These companies needed less physical assets to produce profits, and their tangible book values were less meaningful as a measure of value.  Many value investors had to adopt and began to look more closely at earnings--based models of valuation.  Radio and television stations and newspapers were examples of businesses that could generate enormous earnings with little in the way of physical assets and thus had fairly low tangible book value.  The ability to learn new ways to look at value allows you to make some profitable investments that you might well have overlooked had you not adopted wit the times.


3.  Earnings growth 
There was a great deal of money to be made buying companies that could grow their earnings at a faster rate than the old industrial type companies.  Warren Buffett said that growth and value are joined at the hip.  The difference between growth and value was mostly a question of price.  Paying a little more than just buying stocks based on book value and the investors found great bargains like American Express, Johnson & Johnson, and Capital Cities Broadcasting.  Companies like these were able, and in many cases still are able, to grow at rates significantly greater than the economy overall and were worth a higher multiple of earnings than a basic manufacturing business..


4.  Leveraged buyout business
In the mid-1980s, the leveraged buyout business (LBO) was born.  The US economy was emerging from a period of high inflation and high interest rates.  Inflation had increased the value of the assets of many companies.  For example, if ABC Ice Cream had built a new factory 5 years ago for $10 million and was depreciating it over  10 year period, it would have been written down to $5 million on ABC's books.  However, after  years of inflation, it might cost $15 million to replace that factory.  Its value is understated on the company's books.  Using the factory as collateral, the company might have been able to borrow 60% of its current value or $9 million.  This is what LBO firms did with all sorts of assets in the 1980s.  They would borrow against  company's assets to finance the purchase of the company.

The record high interest rates of the late 1970s and early 1980s drove stock prices to their lowest levels in decades.  The price-to-earnings ratio of the Standard & Poor's 500 was in the single digits.  With long-term Treasury bonds yielding 14%, who needed to own stocks?  The combination of significant undervalued collateral and low PE ratios made many companies ripe for acquisition at very low prices.  

A typical deal in the mid-1980s might be done at only 4.5 or 5 times pretax earnings.  Today, that number is more in the range of 9 to 12 times pretax earnings.  This period was a once-in-a-lifetime opportunity to buy companies at record cheap prices in terms of both assets and earnings.

By using this model to screen for companies that are selling in the stock market at a significant discount to what an LBO group might pay, this  LBO model gave one more way of defining "cheap"


{Summary:  Price to Book Value, Price to Earnings and Leveraged Buyout Appraisal Value]




Value Investing

The basic idea of buying stocks for less than they are worth and selling them as they approach their true worth is at the heart of value investing.

The methods and criteria have changed over the years and they will evolve further with the march of time and inevitable change.  What is important is that the principles have not changed.

On balance, value investing is easier than other forms of investing.  It is not necessary to spend eight hours a day glued to a screen trading frenetically in and out of stocks.  By paying attention to the basic principle of buying below intrinsic value with a margin of safety and exercising patience, investors will find that the value approach continues to offer investors the best way to beat the stock market indexes and increase wealth over time.



Patience is sometimes the hardest part of using the value approach 

When you find a stock that sells for 50% of what you determined it is worth , your job is basically done.  Now it is up to the stock. 

• It may move up toward its real worth today, next week, or next year.  
• It may trade sideways for 5 years and then quadruple in price.  
• There is simply no way to know when a particular stock will appreciate, or if, in fact, it will.   

There will be periods when the value approach will under-perform other strategies, and that can be frustrating.

Perhaps even more frustrating are those times when the overall market has risen to such high levels that we are unable to find many stocks that meet our criterion for sound investing.

It is sometimes tempting to give in and perhaps relax one criterion just a bit, or chase down some for the hot money stocks that seem to go up forever.  But, just about the time that value investors throw in the towel and begin to chase performance is when the hot stocks get ice cold.

The Complete VALUE IMVESTING Guide That Works! by K C Chong (Published 2020)

I picked up this book in Popular Bookshop last week for RM 69.90 and has read many pages.

The author K C Chong has been an active participant in i3 investor forum,  and has shared his investing knowledge generously with the many readers in that forum for many years.

You can now refer to this fine book for the many knowledge, and more, that  K C Chong has shared.

Congratulations to K C Chong.

Topics：
Section 1: Before starting to invest
Section 2: The Stock Market
Section 3: Value Investing, the proven successful investing framework
Section 4: Stock Analysis
Section 5: Investing in good companies at reasonable or cheap price
Section 6: Some proven successful investing strategies
Section 7: Miscellaneous topics

Who is KC Chong?

KC Chong is a retired qualified engineer with more than 40 years of experience in stock investing. He is a dedicated value investor & has coached more than 1,000 students on fundamental value investing. He has a Master in Finance degree & writes frequently on investing & personal finance.



Comments by Cold Eye

Cold Eye "Currently there is a shortage of good reading materials on fundamental investing written by local investment gurus for investor especially stock market newbies. The series of articles written by Mr. KC Chong have certainly helped to fill the vacuum. I am confident that this book will bring a lot of benefits to those looking for guidance. I therefore strongly recommend this book to those who are keen to sharpen their acumen in share investments.

Good Portfolio Management and Trading are of maximum value when used with an Appropriate Investment Philosophy

Here are a number of issues that investors should consider in managing their portfolios.

While individual personalities and goals can influence one's trading and portfolio management techniques to some degree, sound buying and selling strategies, appropriate diversification, and prudent hedging are of importance to all investors.

Of course, good portfolio management and trading are of no use when pursuing an inappropriate investment philosophy; they are of maximum value when employed in conjunction with a value investment approach.

The Importance of Trading: Since transacting at the right price is critical, trading is central to value-investment success.

There is nothing inherent in a security or business that alone makes it an attractive investment.

Investment opportunity is a function of price, which is established in the marketplace.

• Whereas some investors are company- or concept-driven, anxious to invest in a particular industry, technology, or fad without special concern for price, a value investor is purposefully driven by price. 
• A value investor does not get up in the morning knowing his or her buy and sell orders for the day; these will be determined in the context of the prevailing prices and an ongoing assessment of underlying values. 

Since transacting at the right price is critical, trading is central to value-investment success. 

• This does not mean that trading in and of itself is important; trading for its own sake is at best a distraction and at worst a costly digression from an intelligent and disciplined investment program. 
• Investors must recognize that while over the long run investing is generally a positive sum activity, on a day-to-day basis most transactions have zero sum consequences. If a buyer receives a bargain, it is because the seller sold for too low a price. If a buyer overpays for a security, the beneficiary is the seller, who received a price greater than underlying business value. 

The best investment opportunities arise when other investors act unwisely thereby creating rewards for those who act intelligently. 

• When others are willing to overpay for a security, they allow value investors to sell at premium prices or sell short at overvalued levels. 
• When others panic and sell at prices far below underlying business value, they create buying opportunities for value investors. 
• When their actions are dictated by arbitrary rules or constraints, they will overlook outstanding opportunities or perhaps inadvertently create some for others. 

Trading is the process of taking advantage of such mispricings.

Your financial well-being is definitely not something to trifle with.

Once you choose to venture beyond U.S. Treasury bills, whatever you do with your money carries some risk.

Don't think you can avoid making a choice; inertia is also a decision.

It took a long time to accumulate whatever wealth you have; your financial well-being is definitely not something to trifle with. 

For this reason, I recommend that you adopt a value-investment philosophy and

• either find an investment professional with a record of value-investment success 
• or commit the requisite time and attention to investing on your own.

Areas of Opportunity for Value Investors: Catalysts

Owning securities with catalysts for value realization 


The attraction of some value investments is simple and straightforward: ongoing, profitable, and growing businesses with share prices considerably below conservatively appraised underlying value. 

• Ordinarily, however, the simpler the analysis and steeper the discount, the more obvious the bargain becomes to other investors. 
• The securities of high-return businesses therefore reach compelling levels of undervaluation only infrequently. 

Usually investors have to work harder and dig deeper to find undervalued opportunities, either by ferreting out hidden value or by comprehending a complex situation. 

Once a security is purchased at a discount from underlying value, shareholders can benefit immediately

• if the stock price rises to better reflect underlying value or 
• if an event occurs that causes that value to be realized by shareholders. 

Such an event eliminates investors' dependence on market forces for investment profits.

• By precipitating the realization of underlying value, moreover, such an event considerably enhances investors' margin of safety. 

I refer to such events as catalysts. 

• Some catalysts for the realization of underlying value exist at the discretion of a company's management and board of directors. The decision to sell out or liquidate, for example, is made internally. 
• Other catalysts are external and often relate to the voting control of a company's stock. Control of the majority of a company's stock typically allows the holder to elect the majority of the board of directors.  Thus accumulation of stock leading to voting control, or simply management's fear that this might happen, could lead to steps being taken by a company that cause its share price to more fully reflect underlying value. 

Catalysts vary in their potency. 

• The orderly sale or liquidation of a business leads to total value realization. 
• Corporate spinoffs, share buybacks, recapitalizations, and major asset sales usually bring about only partial value realization. 
• The emergence of a company from bankruptcy serves as a catalyst for creditors.  Holders of senior debt securities, for example, typically receive cash, debt instruments, and/or equity securities in the reorganized entity in satisfaction of their claims. The total market value of these distributions is likely to be higher than the market value of the bankrupt debt; securities in the reorganized company will typically be more liquid and avoid most of the stigma and uncertainty of bankruptcy and thus trade at higher multiples.  Moreover, committees of creditors will have participated in determining the capital structure of the reorganized firm, seeking to create a structure that maximizes market value. 

Value investors are always on the lookout for catalysts. 

• While buying assets at a discount from underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. 
• Furthermore, the presence of a catalyst serves to reduce risk. If the gap between price and underlying value is likely to be closed quickly, the probability of losing money due to market fluctuations or adverse business developments is reduced. 
• In the absence of a catalyst, however, underlying value could erode; conversely, the gap between price and value could widen with the vagaries of the market. 

Owning securities with catalysts for value realization is therefore an important way for investors to reduce the risk within their portfolios, augmenting the margin of safety achieved by investing at a discount from underlying value.  


Catalysts that bring about total value realization are, of course, optimal.  Nevertheless, catalysts for partial value realization serve two important purposes.

• First, they do help to realize underlying value, sometimes by placing it directly into the hands of shareholders such as through a recapitalization or spinoff and other times by reducing the discount between price and underlying value, such as through a share buyback. 
• Second, a company that takes action resulting in the partial realization of underlying value for shareholders serves notice that management is shareholder oriented and may pursue additional value-realization strategies in the future. 
• Over the years, for example, investors in Teledyne have repeatedly benefitted from timely share repurchases and spinoffs.

Value Investing and Contrarian Thinking

Value investing by its very nature is contrarian. 

Out-of-favor securities may be undervalued; popular securities almost never are. 


What the herd is buying is, by definition, in favor.

• Securities in favor have already been bid up in price on the basis of optimistic expectations and are unlikely to represent good value that has been overlooked. 

If value is not likely to exist in what the herd is buying, where may it exist?

• In what they are selling, unaware of, or ignoring. 
• When the herd is selling a security, the market price may fall well beyond reason. 
• Ignored, obscure, or newly created securities may similarly be or become undervalued. 

Investors may find it difficult to act as contrarians for they can never be certain whether or when they will be proven correct. 

• Since they are acting against the crowd, contrarians are almost always initially wrong and likely for a time to suffer paper losses. 
• By contrast, members of the herd are nearly always right for a period. 
• Not only are contrarians initially wrong, they may be wrong more often and for longer periods than others because market trends can continue long past any limits warranted by underlying value. 

Holding a contrary opinion is not always useful to investors, however.

• When widely held opinions have no influence on the issue at hand, nothing is gained by swimming against the tide. 
• It is always the consensus that the sun will rise tomorrow, but this view does not influence the outcome. 

By contrast, when majority opinion does affect the outcome or the odds, contrary opinion can be put to use. 

• When the herd rushes into home health-care stocks, bidding up prices and thereby lowering available returns, the majority has altered the risk/reward ratio, allowing contrarians to bet against the crowd with the odds skewed in their favor. 
• When investors in 1983 either ignored or panned the stock of Nabisco, causing it to trade at a discount to other food companies, the risk/reward ratio became more favorable, creating a buying opportunity for contrarians.

Where to look for opportunities: The Challenge of Finding Attractive Investments

Investment Research: The Challenge of Finding Attractive Investments 

While knowing how to value businesses is essential for investment success, the first and perhaps most important step in the investment process is knowing where to look for opportunities. 

Investors are in the business of processing information, but while studying the current financial statements of the thousands of publicly held companies, the monthly, weekly, and even daily research reports of hundreds of Wall Street analysts, and the market behavior of scores of stocks and bonds, they will spend virtually all their time reviewing fairly priced securities that are of no special interest.


Good investment ideas are rare and valuable things, which must be ferreted out assiduously.

• They do not fly in over the transom or materialize out of thin air. 
• Investors cannot assume that good ideas will come effortlessly from scanning the recommendations of Wall Street analysts, no matter how highly regarded, or from punching up computers, no matter how cleverly programmed, although both can sometimes indicate interesting places to hunt. 

Upon occasion attractive opportunities are so numerous that the only limiting factor is the availability of funds to invest; typically the number of attractive opportunities is much more limited.

• By identifying where the most attractive opportunities are likely to arise before starting one's quest for the exciting handful of specific investments, investors can spare themselves an often fruitless survey of the humdrum majority of available investments. 

Value investing encompasses a number of specialized investment niches that can be divided into three categories:

• securities selling at a discount to breakup or liquidation value, 
• rate-of-return situations, and 
• asset-conversion opportunities. 

Where to look for opportunities varies from one of these categories to the next.

• Computer-screening techniques, for example, can be helpful in identifying stocks of the first category: those selling at a discount from liquidation value. Because databases can be out of date or inaccurate, however, it is essential that investors verify that the computer output is correct. 
• Risk arbitrage and complex securities comprise a second category of attractive value investments with known exit prices and approximate time frames, which, taken together, enable investors to calculate expected rates of return at the time the investments are made. Mergers, tender offers, and other risk-arbitrage transactions are widely reported in the daily financial press-the Wall Street Journal and the business section of the New York Times-as well as in specialized newsletters and periodicals. Locating information on complex securities is more difficult, but as they often come into existence as byproducts of risk arbitrage transactions, investors who follow the latter may become aware of the former. 
• Financially distressed and bankrupt securities, corporate recapitalizations, and exchange offers all fall into the category of asset conversions, in which investors' existing holdings are exchanged for one or more new securities. Distressed and bankrupt businesses are often identified in the financial press; specialized publications and research services also provide  information on such companies and their securities. Fundamental information on troubled companies can be gleaned from published financial statements and in the case of bankruptcies, from court documents. Price quotations may only be available from dealers since many of these securities are not listed on any exchange. Corporate recapitalizations and exchange offers can usually be identified from a close reading of the daily financial press. Publicly available filings with the Securities and Exchange Commission (SEC) provide extensive detail on these extraordinary corporate transactions. 

Many undervalued securities do not fall into any of these specialized categories and are best identified through old-fashioned hard work, yet there are widely available means of improving the likelihood of finding mispriced securities.

• Looking at stocks on the Wall Street Journal's leading percentage-decline and new-low lists, for example, occasionally turns up an out-of-favor investment idea. 
• Similarly, when a company eliminates its dividend, its shares often fall to unduly depressed levels. 
• Of course, all companies of requisite size produce annual and quarterly reports, which they will send upon request. Filings of a company's annual and quarterly financial statements on Forms 10K and 10Q, respectively, are available from the SEC and often from the reporting company as well. 
• Sometimes an attractive investment niche emerges in which numerous opportunities develop over time. One such area has been the large number of thrift institutions that have converted from mutual to stock ownership. Investors should consider analyzing all companies within such a category in order to identify those that are undervalued. Specialized newsletters and industry periodicals can be excellent sources of information on such niche opportunities.

Three central elements to a value-investment philosophy.

There are three central elements to a value-investment philosophy.

• First, value investing is a bottom-up strategy entailing the identification of specific undervalued investment opportunities.
• Second, value investing is absolute-performance, not relative-performance oriented.
• Finally, value investing is a risk-averse approach; attention is paid as much to what can go wrong (risk) as to what can go right (return).

Value investing is simple to understand but difficult to implement.

Value investors are not super-sophisticated analytical wizards who create and apply intricate computer models to find attractive opportunities or assess underlying value.


The hard part is

• discipline, 
• patience and 
• judgment.  

Investors need

• discipline to avoid the many unattractive pitches that are thrown, 
• patience to wait for the right pitch, and 
• judgement to know when it is time to swing.

Value Investing Shines in a Declining Market

Who's swimming naked?

When the overall market is strong, the rising tide lifts most ships.

Profitable investments are easy to come by, mistakes are not costly, and high risks seem to pay off, making them seem reasonable in retrospect.

As the saying goes, "You can't tell who's swimming naked till the tide goes out."



Torpedo stocks

A market downturn is the true test of an investment philosophy. 

Securities that have performed well in a strong market are usually those for which investors have had the highest expectations.

When these expectations are not realized, the securities, which typically have no margin of safety, can plummet.

Stocks that fit this description are sometimes referred to as "torpedo stocks," a term that describes the disastrous effect owning them. 

For example, the previous share price of a company had reflected investor expectations of high earnings growth.  When the company subsequently announced a decline in first-quarter earnings, the stock was torpedoed.



Securities owned by value investors are often unheralded or just ignored.

The securities owned by value investors are not buoyed by such high expectations.  To the contrary, they are usually unheralded or just ignored. 

In depressed financial markets, it is said, some securities are so out of favour that you cannot give them away.

Some stocks sell below net working capital per share and a few sell at less than net cash (cash on hand less all debt) per share; many stocks trade at an unusually low multiple of current earnings and cash flow and at a significant discount to book value.



A notable feature of value investing is its strong performance in periods of overall market decline. 

Whenever the financial markets fail to fully incorporate fundamental values into securities prices, an investor's margin of safety is high.

Stock and bond prices may anticipate continued poor business results, yet securities priced to reflect those depressed fundamentals may have little room to fall further. 

Moreover, securities priced as if nothing could go right stand to benefit from a change in perception.  

• If investors refocused on the strengths rather than on the difficulties, higher security prices would result.  
• When fundamentals do improve, investors could benefit both from better results and from an increased multiple applied to them. 
• The higher multiple reflected a change in investor psychology more than any fundamental developments at the company.

What is investing? My core.

Investing is all about buying a flow of earnings at an acceptable price.

The pace of earnings growth is a second-order issue.

Risk is the possible loss of long-term purchasing power.

Volatility of price is not risk.  It is the ally of the long-term investor.

The market is NOT ALWAYS efficient.  In general it is efficient, but NOT ALWAYS, and this small difference is crucial, enabling us to capitalise on it.

How do you select your stocks: Quality First, then Value.

A great company deserves a higher valuation. It is possible that you paid a slightly higher price than you wanted to pay for the stock, which lowers your overall rate of return, but time is on your side and your long holding time minimizes the impact of the higher purchase price to your overall return. Also, you will always find the opportunity to add to your position at lower valuations, though not necessarily at lower prices.


Deep value investing investors need to be cautious and aware of this approach's inherent problems. Those companies dropping and appearing in the deep-bargain screen probably deserved to be traded by low valuations. Their stock prices were likely low for the right reasons, and buying these would likely have resulted in steep losses.


How do you select your stocks: Quality First, then Value.

There are many gruesome companies in the stock market. These companies operate in very competitive environments and have to be managed well to deliver good returns. In the business world, it is often the economics of the business that eventually triumph over the skills of the managers, however superb their skills maybe.

A company that performed well for 3 years and then lose its good performance subsequently is not a great company, by definition. A great company is one that can perform well, consistently and growing its earnings over 20 to 30 years.

Not uncommonly, these gruesome companies trade at below their net tangible asset prices. This is to be expected, especially if their businesses continue to be gruesome. Their low trading prices attract some investors who are enticed by the very low price relative to their net asset value.

Here is a very important point for any investor. When the price of a company falls, all its valuation ratios become very good. Its price to book value, its price to sales and its price to earnings ratios, all fall and its dividend yield (using last year's dividends) rises.

The uninitiated may think these companies are now undervalued using these financial ratios. Here lies the risk of searching for undervalued stocks in gruesome companies.

The more intelligent investors do not solely rely on these financial ratios alone, they require a lot more analysis. As a general rule, most shares are priced appropriately most of the time. It is only some of the time, when they are mis-priced too low or too high.

The risk in buying great companies is overpaying too much to own it. However, great companies do have earning power for many years, by definition. They continue to grow their intrinsic value over time. If you can acquire these companies at bargain prices (very rarely) or at fair prices (commonly), you should do well in your long term investing. Also, it is alright to pay a little bit more to own these companies as over the long time of holding them, they will still reward you handsomely. As these great companies are few, selling them only make a lot of sense if you can find another of equal quality (very difficult indeed) that offers higher reward to downside risk with high degree of probability. Well, not unexpected, this is not easy.

Buffett says: Buying a wonderful company at a fair price is better than buying a fair company at a wonderful price. He is absolutely right. Stay with quality first, then value; and your investing over the long term should be quite safe and mistakes, if any, will be few.

Walter Schloss: Making money out of junk

Walter Schloss made 21% per year for 47 years, investing in a simple, methodical, low stress manner working 9-4:30 with no other employees or assistants other than his son Edwin.

Here are some key takeaways from the interesting Forbes piece:

• Focus on cheap stocks. This means not worrying about earnings at the moment, only asset protection.
• You have three things in your favor here:
• Earnings turn around and the stock appreciates significantly
• Someone buys control of the company (buyout)
• The company begins buying its own stock (share-buyback)

Read the whole article here:

http://basehitinvesting.com/wp-content/uploads/2012/11/Making-Money-Out-of-Junk.pdf

http://basehitinvesting.com/walter-schloss-1973-forbes-article-two-ways-to-outperform-the-market/?fbclid=IwAR3Qv5txUFIKimx75SCguoZdeODT6Wu79-tC3CJ6EAlSBmakr0g1KrGGHCY

Deep Value Investing has its Inherent Problems.

Buffett said it best:

Unless you are a liquidator, that kind of approach to buying businesses is foolish.

• First, the original 'bargain' price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces - never is there just one cockroach in the kitchen. 
• Second, any initial advantage you secure will be quickly eroded by the low return that the business earns ...

There are better ways to make money (see below).


Warren Buffett, Berkshire Hathaway shareholder letter, 1989.
http://www.berkshirehathaway.com/letters/1989.html





When the overall market valuation is high, and everything else is rising, those dropping and appearing in the deep-bargain screener probably deserved to be traded by low valuations.

• Their stock prices were likely low for the right reasons, and buying these would likely have resulted in deep losses.
• Therefore, when it comes to deep-value investing, investors need to be cautious and aware of this approach's inherent problems.

The inherent problems with deep value investing

"Cigar-butt investing"

This was coined by Buffett for the strategy of buying mediocre businesses at prices that are much lower than the companies' net asset values.

He said the approach is like "a cigar butt found on the street that has only one puff left in it and may not offer much of a smoke, but the "bargain purchase" will make that puff all profit."




There are several problems with this approach.

1. Erosion of value over time.

Mediocre businesses do not create value for their shareholders; instead, they destroy business value over time.

The value of the business can decline and the initial margin of safety may gradually shrink, even if the stock price doesn't go up.

Investors need to be lucky enough to have the stock prices rise in time and sell before prices drop again following the intrinsic value of the business.

"Time is the friend of the wonderful business, the enemy of the mediocre." Buffett wrote in his 1989 shareholder letter.


2. Timing and Pain

Buy these bargain portfolios when you can find plenty of them, but if the broad market is in quick decline, like in 2008, the bargain portfolio will be very likely to lose much more than the general market.

• If the decline lasts longer, many of the companies in the portfolio may suffer steeper operating losses and may even go out of business.
• It is much more painful to hold such a portfolio in bad times, as anyone who owns these stocks during bear markets or recessions will attest - and lose much sleep over.

Because of the quick erosion of business value, selling the deep-asset bargains quickly is key, even if stock prices do not appreciate. The biggest profits are usually achieved within the first 12 months.

"If you buy something because it is undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That's hard." (Charlie Munger.)

Buffett likens buying mediocre businesses at deep bargain prices for a quick profit to dating without the intent of getting married. In that situation, it is essential to end the courtship at the right time and before the relationship turns sour.


3. Not Enough Stocks Qualify

To avoid errors and disasters caused by single stocks in the deep-bargain portfolio, it is important to have a diversified group of them.

But when the market valuation is high, it is just not possible to find enough stocks to satisfy the diversification requirement. They simply dried up as the market continued to tick higher.

This situation may last a long time, as the close-to-zero interest rate has lifted the valuations of all assets.


4. Tax Inefficiency

Because of the short holding time, any gain from the portfolio is subject to the same tax rate as the investor's income tax (for U.S. investors, unless it is in a retirement account.)

This drastically reduces the overall return over the long term.




If buying mediocre businesses at deep bargain prices for a quick profit is like a date without the intent of getting married, buying them and getting involved long term is like a marriage without love. A lot of other things need to be right to work things out, and it will never be a happy marriage.




Important Notes on Deep-Asset Bargains strategy


Though buying deep-asset bargains can be very profitable, this strategy comes with its inherent problems.

- This strategy comes with a much higher mental cost to investors.

- More importantly, business deterioration and the erosion of value put investors in a riskier position.

- As a result, they need to strictly follow the rules of maintaining a diversified portfolio and selling within 12 months whether investments worked out or not.




Ask yourself:

Why would you, as an investor, want to get involved in this mess (a deep-asset-bargain) and witness things deteriorating, hoping the situation will improve?

Even if it works out eventually, which is very unlikely (in the majority), the mental and psychological drain is simply not worth it.



There are better ways to make money.

Buy Only Good Companies!


"Bargain-purchase folly."


Instead of buying companies with deteriorating values on the cheap and hoping things will improve, why not buy companies that grow value over time?

Warren Buffett summarized in a single sentence the priceless lessons he learned from his personal "bargain-purchase folly".

"It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price."