Showing posts with label value investor. Show all posts
Showing posts with label value investor. Show all posts

Monday 18 May 2020

Differences between Value Investors

The distinction between price and value is the sole requisite principle of value investing. It’s the only must. Beyond that, there are valid differences in  approach. I see eight.


1.  First is
asset class. 
Listed equities return best over time, as addressed. But there are practitioners able to squeeze performance out of other sorts of holdings. Bonds work for some, real estate works for others. They’re tougher rows to hoe, but some hoe them well.

2.  A second valid difference is
holding period
Some value investors plan to hold what they buy for just months. Others hope to hold indefinitely. Different timelines occasion different priorities. For example, short-term holders consider catalysts. A catalyst is a reason that a price could soar from the depressed level that helped to make a security attractive. Unexpectedly good quarterly results could be a catalyst, as could the dismissal of an unpopular executive.

Catalysts are less interesting to long-term investors. They’re too near-term a concern. Never intending to sell, I don’t give them a thought. 


3.  A third valid difference is activism. 
Activist investors agitate for change in the companies that they own. They might be viewed as their own catalysts. The alternative is staying uninvolved. It’s the choice of most investors, both good and bad. I call it inactivism, since passive implies index fund investing.

Activism requires an extraordinary level of gravitas and tenacity. People who are feared and skilled in this specialty are the ones that achieve the best results. Activism is not something in which one fruitfully dabbles.



4.  Fourth is diversification. 
Some value investors have diversified portfolios, with perhaps 50 or more names. Others prefer concentration, with fewer than 10.

These thresholds depend somewhat on the amount of money managed. A $50,000 portfolio spread out among a dozen different stocks might be considered diversified, while a $10 billion fund invested in a dozen names might seem concentrated.


Diversification tends to decrease volatility, should that be a goal. But
, the more diversified a portfolio is, the harder it is to beat a relevant index.

One way to appreciate this is through the
law of large numbers. It’s a principle from probability. It says that the more times an experiment is run, the closer the average result will be to the expected result. In investing, the expected result is the index’s return. So the more names in the portfolio—each name being an experiment, in the parlance of the law—the closer the portfolio’s return will
be to that of the index.


Some stripes of value investing force one into a diversified portfolio. Small cap investing can, since there aren’t that many shares traded of each company.  
They’re small. So a small-cap investor that adds $100,000 to assets under management might have to find a new name because the ones already owned don’t have enough shares available to buy.


5.  A fifth valid difference is
quality. 
Our approach has been to focus on how good a business is in an absolute sense, before considering price. We labor over historic performance metrics, strategic positioning, and shareholder-friendliness. We look for quality.

But an equally convinced group focuses on buying companies that are inexpensive relative to how good they are. To them garbage is fine, as long as it’s cheap garbage. Some in this group get exceptional results.


My focus on company quality reflects three of my other preferences: inactivism, concentration, and a long holding period. What I buy has to be good because I’m not going to fix it, I’ve only got a few others like it, and it’s mine forever.


These preferences aren’t about great foresight or morality. They’re about taxes. Unrealized appreciation isn’t taxed in the United States, so everything else being equal, holding is advantageous. I draw a straight line from tax policy to investment policy.



6.  Sixth is
leverage
Leverage is debt. What is true for operating companies is true for investors: debt amplifies results. When an investor buys on margin, results that would otherwise be good become exceptional, and results that would otherwise be bad become catastrophic. The potential of the latter keeps many value investors away from debt. But not all.



7.  Seventh is complexity. 
Some value investors prefer simple setups. They like common stock in straightforward companies. I do, as the model makes clear. But others like it complicated. They may seek convertible bonds that become equity only under hard-to-forecast circumstances. They may prefer stock in development-stage pharmaceutical companies undergoing clinical trials, or in technology companies whose fortunes are dependent on the outcome of pioneering research.

They adore these complications not because they’re falling prey to the cleverness bias. They adore them because it gives them less buy-side competition. Other investors will simply abstain from trying to sort out convoluted situations. This can keep prices lower than they would be otherwise.



8.  Eighth is
shorting. 
Shorting is a way to bet on a stock price’s decline. It involves selling stock without actually owning it, by renting it from someone who does, with the goal of profiting when the price falls.

Shorting is theoretically attractive. It promises a way to benefit from a finding that a security is overpriced. But it’s thorny to implement. Shares to rent can be hard to find, fees can be high, and a
short squeeze can cause a price meant to plunge to actually soar.

Despite these complications, some value investors do short. But many do so as agents, not as principals. That’s because it increases their compensation. 
Shorting is a hallmark of a complicated fund. It’s the kind of stunt that managers attempt in order to justify compensation schemes of 2 percent plus 20 percent. It’s a ticket out of the land of 1 percent.




Dicey Strategies:  Can work and Doesn't work sometimes

Of the eight dimensions on which value investors can differ, two invite suspicion. 


1.  Shorting is one. 
It just doesn’t work that well. I know of no principals that both rely on shorting and outperform over the long term.

2.  Leverage is the other. 

While debt can be milked for bonus returns much of the time, one big margin call can be enough to foul years of solid results.



I nonetheless include shorting and leverage on the list to allow for the possibility that they could be made to work under some circumstances. 


  • But they’re dicey. 
  • They’re back doors out of the kingdom of value investing and into a land of some other, less practical strategy. 
  • Some would say that this invalidates them as intelligent tactics. 
To those with long-term perspectives, something that doesn’t work sometimes can ultimately be indistinguishable from something that doesn’t work at all.



Summary

Dimensions on which bona fide value investors can differ include:

1. Asset class

2. Holding period

3. Activism

4. Diversification

5. Quality

6. Leverage

7. Complexity

8. Shorting

Monday 13 January 2020

Areas of Opportunity for Value Investors

The theme: that attractive opportunities to purchase undervalued investments arise with some frequency in a number of areas and that these opportunities can be identified and exploited by value investors.

Sunday 12 January 2020

Three elements of a value-investment strategy: Bottom-up approach, Absolute performance orientation, and Managing risk.

The primary goal of value investors is to avoid losing money. 

Three elements of a value-investment strategy make achievement of that goal possible.

1.   A bottom-up approach, searching for low-risk bargains one at a time through fundamental analysis, is the surest way I know to avoid losing money.

2.  An absolute performance orientation is consistent with loss avoidance; a relative-performance orientation is not.

3.  Finally, paying careful attention to risk - the probability and amount of loss due to permanent value impairments - will help investors avoid losing money.



So long as generating portfolio cash inflow is not inconsistent with earning acceptable returns, investors can reduce the opportunity cost resulting from interim price declines even as they achieve their long-term investment goals.

Sunday 15 October 2017

Value of a Business to a Private Owner

Value of a Business to a Private Owner Test

The private-owner test would ordinarily start with the net worth as shown in the balance sheet.


How to search for a bargain opportunity?

1.  Using the net worth as the starting point

The question to ask is:  Is the indicated earnings power sufficient to validate the net worth as a measure of what a private buyer would be justified in paying for the business as a whole?

If the answer is definitely yes, an ordinary investor should find the common stock attractive at a price one-third or more below such a figure.  


2.  Using the working capital as the starting point

If instead of using all the net worth as a starting point, the investor considered only the working capital and applied his test to that, he would have a more convincing demonstration of the existence of a bargain opportunity.

For it is something of an axiom or is self evident, that a business is worth to any private owner AT LEAST the amount of its working capital, since it could ordinarily be sold or liquidated for more than this figure.

If a common stock can be bought at no more than two-thirds of the working capital value alone - disregarding all the other assets - and if the earnings record and prospects are reasonably satisfactory, there is strong reason to believe that the investor is getting substantially more than his money's worth.



An example of how to find a bargain common stock:

[Peculiarly, in 1947, many such opportunities present themselves in ordinary markets.  Benjamin Graham]

National Department Stores as of January 31, 1948, the close of its fiscal year.
The price of the stock was 16 1/2.
The working capital was no less than $26.60 per share.
The total asset value was $33.30.
Deducting contingency reserves - mainly to mark down the inventory to a "LIFO" (last in first out) basis, these figures would be reduced by $2.20 per share.

The company had earned $4.12 per share in the year just closed.  The seven-year average was $3.43; the twelve-year average was $2.29.  (Growing earnings)
The year's dividend had been $1.50.  (Paying dividends)
Compared with a decade before,
-  the working-capital value had risen from $7.40 per share to $26.60,
-  the sales had doubled and (Increasing sales)
-  the net after taxes had risen from $654,000 to $3,224,000.  (Increasing profits)


Thus, we had a business
-  selling for $13 million,
-  with $25 million of assets, mostly current.  (Price < Net Assets)
-  Its sales were $88 million.  A fair estimate of average future earnings might be $2 million. (earnings record and prospects are reasonably satisfactory  or Not gruesome)

The average earnings prior to 1941 had been unimpressive, and the company was regarded as a "marginal" one in its field - that is, it could earn a reasonably good return only under favourable business conditions.  (Qualitative assessment)

In the past eight years, however, it has improved both in financial strength and in the quality of its management.  (Qualitative assessment - earnings record and prospects are reasonably satisfactory or improving quality of business and management)

Let us grant that Wall Street would still consider the company as belonging in the second rank of department-store enterprises.  (Investor sentiment/Market sentiment/Neglected by market)

Even after proper allowance is made for such an unfavourable factor, we may still conclude that on the basis of the figures the stock is intrinsically worth well above its market price.  (Worse case scenario, still Value > Price)


Conclusion:  At 16 1/2, the conclusion in the case of National Department Stores remains, whether we apply the appraisal test or the test of value to a private owner.  (Undervalued / A bargain)



Friday 20 December 2013

Temporary Price Fluctuations is to be expected. It is not possible to avoid random short-term market volatility.

Relevance of Temporary Price Fluctuations 

In addition to the probability of permanent loss attached to an investment, there is also the possibility of interim price fluctuations that are unrelated to underlying value. 

Many investors consider price fluctuations to be a significant risk: if the price goes down, the investment is seen as risky regardless of the fundamentals.


But are temporary price fluctuations really a risk?  

-  Not in the way that permanent value impairments are and then only for certain investors in specific situations. 

-  It is, of course, not always easy for investors to distinguish temporary price volatility, related to the short-term forces of supply and demand, from price movements related to business fundamentals.

-  The reality may only become apparent after the fact. 

-  While investors should obviously try to avoid overpaying for investments or buying into businesses that subsequently decline in value due to deteriorating results, it is not possible to avoid random short-term market volatility.

-  Indeed, investors should expect prices to fluctuate and should not invest in securities if they cannot tolerate some volatility. 



If you are buying sound value at a discount, do short-term price fluctuations matter? 

-  In the long run they do not matter much; value will ultimately be reflected in the price of a security.

-  Indeed, ironically, the long-term investment implication of price fluctuations is in the opposite direction from the near-term market impact. 

-  For example, short-term price declines actually enhance the returns of long-term investors.



There are,however, several eventualities in which near-term price fluctuations do matter to investors. 

1. Security holders who need to sell in a hurry are at the mercy of market prices. 

- The trick of successful investors is to sell when they want to, not when they have to.


2.  Near-term security prices also matter to investors in a troubled company. 

-  If a business must raise additional capital in the near term to survive, investors in its securities may have their fate determined, at least in part, by the prevailing market price of the company's stock and bonds.


3. The third reason long-term-oriented investors are interested in short-term price fluctuations is that Mr. Market can create very attractive opportunities to buy and sell. 

-  If you hold cash, you are able to take advantage of such opportunities. 

-  If you are fully invested when the market declines, your portfolio will likely drop in value, depriving you of the benefits arising from the opportunity to buy in at lower levels.

-  This creates an opportunity cost, the necessity to forego future opportunities that arise
.
-  If what you hold is illiquid or unmarketable, the opportunity cost increases further; the illiquidity precludes your switching to better bargains.



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