Valuing Hidden assets

Hidden assets

In addition to assets appearing on a going concern’s balance sheet, numerous resources bearing value do not appear under GAAP. These so-called hidden assets include:

• Brand-name identity
• Product qualities
• Know-how
• Employee training
• Specialized production
• Distribution arrangements.

For example, a new entrant might need to invest in research and development (R&D) to replicate the target company. The exact value is difficult to estimate.

An informed guess can be made by estimating the life cycle of the resulting product and multiplying this by the target’s average annual level of R&D expense.

For a patented pharmaceutical, for example, product life could be up to the 17-year life of a patent. So if the company spends 5 percent annually on R&D for its patented products, an amount equal to about 85 percent of current revenues would be warranted.

Similar estimating is appropriate to value customer relationships. These take time and resources to build. They may be judged by some multiple of the target’s annual selling and administrative expenses – perhaps between one and three years’ worth of these.

Additional estimating goes into other hidden assets such as

• government licenses,
• franchise agreements, and
• other valuable resources

that are not listed on a balance sheet under standard accounting rules.


Also read:
1.Balance Sheet Value: Assets at Work
2.Reliability of financial data
3.Asset valuation approach in liquidation
4.Asset valuation approaches in active companies
5.Valuing Hidden assets
6.Subtracting liabilities in asset valuation
7.Balance Sheet Value: Summary

Asset valuation approaches in active companies

Going concerns

For a going concern, three asset valuation approaches are recognized:

• Net-net working capital
• Book value
• Reproduction cost method

Net-net working capital

The most conservative form of value investing examines solely current assets, subtracts all liabilities, and estimates the difference as the company’s value.

Graham made this famous as the net-net working capital figure.

If the target is selling for less than that difference, a sizable margin of safety exists.

It is somewhat impractical, however, for few companies today operate using current assets that are greater than total liabilities.

Such results are as rare as hen’s teeth today.

Book value

If a company can be bought for a per-share price equal to less than the difference between its reported total assets and reported total liabilities, it probably furnishes a comfortable margin of safety as well.

While such companies sometimes exist in contemporary corporate America, they too are not common.

Also, value investing inclines some scepticism towards reported figures, justifying consideration of the third method of asset valuation called the reproduction cost method.

Reproduction cost method

In the reproduction cost method of balance sheet valuation, the concept is to value a going concern on the basis of what it would take a new entrant to its business to build it from scratch at current costs or replacement value.

All a target’s resources and claims against it are separately assessed and netted out. The cash, securities, receivables, and inventory probably can be taken at face value, as can prepaid expenses.

• Investigation is required to ensure that receivables have been adequately reserved through the allowance for bad debt accounts.
• Further investigation is required to ensure that inventory accounting is neither overstated (due to aging that suggests they are non-saleable for example) nor understated (due to inflation in sales prices compared to historical records concerning the cost of those goods held for sale).
• Fixed assets should be adjusted to reflect current market conditions, compared to the historical prices (net of depreciation) at which they are carried on the books.
• Accounting goodwill remains an asset class warranting little valuation accretion.

Also read:
1.Balance Sheet Value: Assets at Work
2.Reliability of financial data
3.Asset valuation approach in liquidation
4.Asset valuation approaches in active companies
5.Valuing Hidden assets
6.Subtracting liabilities in asset valuation
7.Balance Sheet Value: Summary

Asset valuation approach in liquidation

Liquidation

Liquidation value is the net realizable amount that could be generated by selling a company’s assets and discharging all its liabilities.

When valuing a business for liquidation, most assets are marked down and the liabilities treated at face value.

• Cash and securities are taken at face value.
• Receivables require a small discount (perhaps 15 percent to 25 percent off).
• Inventory a larger discount (perhaps 50 percent to 75 percent off).
• Fixed assets at least as much as inventory.
• Any goodwill should probably be ignored.
• Most intangible assets and prepaid expenses should be ignored.

The residual is the shareholders’ take.

This valuation method is useful for companies being dissolved.

It doesn’t consider value arising from deploying the resources in combination. It is thus of limited use for valuing businesses as going concerns.


Also read:
1.Balance Sheet Value: Assets at Work
2.Reliability of financial data
3.Asset valuation approach in liquidation
4.Asset valuation approaches in active companies
5.Valuing Hidden assets
6.Subtracting liabilities in asset valuation
7.Balance Sheet Value: Summary

Reliability of financial data

Key Insight into Reliability of financial data

A key insight about Graham and value investing endures. This focus relates to the data’s reliability.

Current assets are the most reliable of all financial data. Valuation data become more unreliable as one moves down:

• the balance sheet from cash into longer-term current assets and into long-term assets,
• into the income statement and down it, and
• onto the cash flow statement.

Balance sheet data becomes less reliable for valuation because items tend to be more firm- or industry-specific:

· Every business can use cash so a dollar held is pretty much worth a dollar.

· Accounts receivable are generally more easily collected by the company that generated them, but they can be assigned or sold, and the buyer can collect most of what the company could (this commonly occurs by the process of factoring in the textile industry for example).

· Inventory can be used only by other merchandisers or manufacturers in the same or similar industries.

· Property, plant and equipment may be less adaptable even by peers, or can be illiquid.

· Goodwill is all but unique to a firm (other intangible assets such as trademarks, patents, and copyrights typically don’t appear on the balance sheet).


Also read:
1.Balance Sheet Value: Assets at Work
2.Reliability of financial data
3.Asset valuation approach in liquidation
4.Asset valuation approaches in active companies
5.Valuing Hidden assets
6.Subtracting liabilities in asset valuation
7.Balance Sheet Value: Summary

Balance Sheet Value: Assets at Work

Balance Sheet Value: Assets at Work

Pure value investing starts with the balance sheet, the list of assets and liabilities, and the resulting difference called book value.

The following metrics can be derived:
· Net-net working capital
· Net asset value
· Liquidation value, and
· Reproduction cost

In some areas, our economic environment has outpaced our accounting principles so that sizable asset classes called intangibles bearing large values remain unrecorded on the asset side of a balance sheet.

Examples are:
· Intellectual property (copyrights, patents, and trademarks), and
· Human capital (a well-trained workforce, know-how, and specialized skill sets).


Also read:
1.Balance Sheet Value: Assets at Work
2.Reliability of financial data
3.Asset valuation approach in liquidation
4.Asset valuation approaches in active companies
5.Valuing Hidden assets
6.Subtracting liabilities in asset valuation
7.Balance Sheet Value: Summary

What data most reliably indicate value

While all investors agree that intrinsic worth is the present value of cash that an asset generates for its owners, serious disagreement arises concerning the factors used to estimate cash flows and the relevant discount rate.

Debate concerning cash flows focuses on what data most reliably indicate this value.

Cash flows are picture of the future, and gauging the future can only be done by drawing on the past.

Historical indicators

Which historical indicators are the best gauges of future performance?

Candidates include:

• historical cash flows themselves,
• recent earning history, and
• existing asset and liability levels.

Even among prominent value investors, emphasis varies concerning which gauges are best suited for valuation exercises.

All agree that in order of importance, analysis must focus on

• the balance sheet,
• the income statement, and
• the cash flow statement.

Also read:

Valuation

1. Value Measurements

2. Hunting for good investment prospects

3. What data most reliably indicate value

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

Value Measurements

Value Measurements

The value of any asset (stock, bond, business, or other) is a function of the cash inflows and outflows, discounted at an appropriate rate that an investor can reasonably expect it to generate during its remaining life.

Bonds

Bond values are easiest to measure.

Standard bonds bear a designated interest rate and a set maturity date.

The combination defines expected cash flows and appropriate discount rate.

Stocks

Common stocks have no such coupon, and their life is perpetual.

An analyst thus must estimate both components (expected cash flows and discount rate) of the valuation exercise.


Another crucial difference is that qualitative variables such as managerial probity and skill have a direct bearing on common stock values, but a limited effect on bond values.


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

Shares are cheap but it's not the time to buy

Shares are cheap but it's not the time to buy
Three days after Lehman Brothers collapsed in mid-September, stock markets were in freefall.

By Chris Hughes, breakingviews.com
Last Updated: 6:33AM GMT 09 Jan 2009

The world looked so gloomy that some equity investors hailed the week as the so-called "capitulation event" - the painful point of maximum bearishness that clearly establishes the trough of the market. The announcement of the US Troubled Asset Relief Programme arrested the selling.

But by late November, the MSCI World Index and S&P500 had fallen another 35pc. Equities had fallen 54pc from their October 2007 high, before the worst of the crisis hit.

Equity investors never know when they are at the bottom. But if the market rout prompted by Lehman was a false floor, the rally since late November is proving resilient. As of January 8, the World Index was up 22pc from last year's low, touched only seven weeks earlier. The question facing equity investors is whether this is just another bear-market rally, and, if not, how quickly markets will continue to recover.

Bear markets usually last longer than two years. But the latest downturn has been particularly accelerated. And there are multiple arguments why equities have now found their floor.

While higher current dividend yields partly reflect the risk of imminent dividend cuts, the equity yields still look good compared to government bonds and cash, whose yields have plummeted. Cash has never looked so expensive. The equity risk premium is at its highest in a decade, according to Morgan Stanley. Furthermore, corporate insiders, who should know something, are buying at record levels.

Analysts expect the recession to cut corporate earnings in half, including a 10pc decline in 2008. But equities appear to have fallen enough to reflect that savage drop. Global equities have not been so cheap on either spot or trough earnings for over two decades, says Citigroup. They are trading on a historic price-earnings ratio of around 11 times. Credit Suisse says historic consensus earnings multiples were an average 15 in the last four market lows.

Stock market history suggests that equity markets recover before bad news from corporations has stopped and while earnings are still falling. Equities can bottom out as early as five quarters before earnings trough, and do so on average after two quarters.
But to be buying now, equity investors need to satisfy themselves of two things.

• First, that earnings will indeed trough this year.
• And second, that this time will not be different, even in the face of a global deleveraging of unprecedented intensity.

Neither of those tests is easily satisfied. The risk that recession will become a slump, while not high, persists.

The massive government stimulus packages that investors hope will underpin recovery carry risks of their own, in particular if weak currencies create an inflationary squeeze on corporate profits. The financial pummeling could slow the pace of any stock market recovery, even if profits are recovering. There must also be doubts about the new normal price-to-earnings ratio is a de-levered world.

And these uncertainties should be sufficient to keep equities cheap for a while yet.

For more agenda-setting financial analysis, visit www.breakingviews.com

http://www.telegraph.co.uk/finance/markets/4205812/Shares-are-cheap-but-its-not-the-time-to-buy.html

Also read:
Investing in time of uncertainties

How Bad Will It Get?

How Bad Will It Get?
By Tim Hanson October 9, 2008 Comments (74)

It's grim out there. The market is down 24% since the beginning of September. The financial contagion that started with the U.S. subprime mortgage defaults has spread to Europe and Asia. Fully 60% of Americans now believe that a depression -- replete with 25% unemployment and widespread homelessness and hunger -- is "likely." And just 9% of Americans, an all-time low, are satisfied with the way things are going in the country.
It's gotten so bad, in fact, that the Booyah Bull himself, Jim Cramer, told investors on Monday to pull any money they need for the next five years out of the market.

Now, that's not necessarily bad advice
Of course, you should never be investing the hard-earned dollars that you need to pay your bills over the next few years. But if you heed the wisdom of the late Sir John Templeton -- whom we recently eulogized as the world's most important investor -- you should always be ready, willing, and able to invest some of your long-term savings in common stocks at -- and this is crucial -- the point of maximum pessimism.
What can happen when you buy at the point of maximum pessimism? Well, as Sir John proved when he famously purchased 100 shares of 104 companies trading for $1 per share or less in 1939, as the market panicked at the outset of World War II, you can make a lot of money.
The good news for you today is that given that data presented above, we're getting pretty darn close to that point -- only 9% of Americans are left to be convinced.

An important caveat
This, however, does not mean that the market has bottomed. It could well get worse before it gets better, particularly since the credit markets remain frozen and home prices look like they have a bit more "rationalizing" to do.
But some stellar businesses are already selling at hefty discounts to the norm:

Company
Current P/E ....5-Year Average P/E

Microsoft (Nasdaq: MSFT)
12.3....25.1
Paychex (Nasdaq: PAYX)
17.9....35.3
Intel (Nasdaq: INTC)
13.4....24.4
Fastenal (Nasdaq: FAST)
20.9....33.9
Ritchie Bros. Auctioneers (NYSE: RBA)
27.2....31.2
Nike (NYSE: NKE)
15.3....20.0
Best Buy (NYSE: BBY)
12.1....22.4
Data from Morningstar.com.

Are you brave enough to start today?
Rather than try to time the market and catch these names on the way back up, start dollar-cost averaging into an array of superior names now (remember, Sir John purchased shares in 104 companies) with a commitment to holding shares for the next five years or more. That's the only time-tested way to turn current market volatility to your advantage, and the rewards will be great for those with the courage and resources to do so.
The key, though (and this bears repeating), is to average in -- keeping some money on the sidelines if the market continues to drop -- and adding new money, even in a small amounts, on a regular basis. That's a particularly prudent tack today, given the low costs of trading and the violent unpredictability of today's stock market.


Tim Hanson owns no shares of any company mentioned ... yet. The Motley Fool owns shares of Best Buy. Microsoft, Intel, and Best Buy are Motley Fool Inside Value recommendations. Best Buy is also a Stock Advisor pick. Paychex is an Income Investor selection.
Read/Post Comments (74)

http://www.fool.com/investing/general/2008/10/09/how-bad-will-it-get.aspx

Satyam: Slumdog Millionaire

Satyam: Slumdog Millionaire
By Rick Aristotle Munarriz January 7, 2009 Comments (32)

SAY it ain't so, Satyam.
Shares of Indian IT outsourcing giant Satyam Computer Services (NYSE: SAY) got pummeled this morning, after Chairman B. Ramalinga Raju admitted that the company's books are cooked.
It's not pretty. Satyam's balance sheet cash is inflated by the rupees equivalent of more than $1 billion, as the result of several years of inflated profits.
"It was like riding a tiger, not knowing how to get off without being eaten," Raju confesses in a note to the company's board, presumably unaware of the chairman's number-crunching trickery. Fearing that the gaps would become public under a buyout -- and the stock had risen yesterday on newspaper reports that it was an acquisition target -- Raju came clean.
Investors knew that something wasn't quite right with Raju. The stock took a spill last month when Raju announced the proposed $1.6 billion purchase of distressed assets. The problem? The targeted Maytas Properties buy consisted of businesses owned by the chairman's sons, and completely unrelated to Satyam's outsourcing stronghold.
"How would shareholders have known whether Satyam was simply bailing out family members by sorely overpaying for these assets?" I asked at the time.
It turns out that it was actually the sons trying to bail out Raju.
"The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones," he confesses.
The crushing Satyam news is having a favorable impact on its rivals. Cognizant Technology (Nasdaq: CTSH) and Infosys (Nasdaq: INFY) are moving higher today, while Wipro (NYSE: WIT) is only trading marginally lower. Rather than focus on the lack of market credibility in India-based companies, savvy investors realize that incensed Satyam customers are likely to head elsewhere for their IT outsourcing needs.
Other Indian-based growth stocks, like online access specialist Sify (Nasdaq: SIFY) and new media player Rediff.com (Nasdaq: REDF), are trading all over the map.
In the critically acclaimed Slumdog Millionaire, the Indian protagonist surprises a quiz show host by knowing all of the right answers. As it turns out, the correct responses typically come from heart-wrenching episodes in his life. Satyam has it the other way around, with investors getting poorer as Raju provides all of the wrong answers.
He is naturally stepping down, ready to face his fate. Satyam will likely settle for a bargain-priced buyout from someone -- anyone -- willing to take a chance on the mystery box of a company that Satyam has become.
"It is written," is how Slumdog Millionaire ends, before breaking into an uplifting Bollywood dance sequence at a train station. Satyam's ending now appears to be more of a train wreck instead.
The painful Satyam saga:
No Heads Rolling at Satyam -- Yet
Satyam Seeks to Build Future for Its Family
How Bad Will It Get?

http://www.fool.com/investing/general/2009/01/07/satyam-slumdog-millionaire.aspx

This Could Destroy Your Retirement: Inflation

This Could Destroy Your Retirement
By Todd Wenning September 10, 2008 Comments (0)

I'm sure none of us has spent time with our grandparents without hearing statements like "I remember when the movies only cost a quarter," and "A thousand dollars sure doesn't buy what it used to."
After a few college economics courses, I simply chalked it up to stuff that grandparents say. Obviously, they just didn't understand the forces of inflation compounded over 40 years.
What a smart aleck But after a recent trip to the grocery store, I caught myself sounding like my grandparents. "Four dollars for milk?" I lamented to my wife. "I remember when a gallon of milk cost $2! And that was just a few years ago."
Without getting into a complex macroeconomic analysis of why milk prices have doubled in eight years, my trip to the grocery store was a valuable reminder of inflation's destructive power.
I don't even want to think about what a gallon of milk will cost when I retire. But I'm still going to want it on my cereal, so it's best to develop a plan now that will let me enjoy my Apple Jacks when I'm 70.

Affording $12 milk in 2040

In May, The Economist reported the average world inflation rate had risen to 5.5%. The U.S. rate is slightly above that figure at 5.6%. In emerging markets like China and India, prices have risen 8% to 10% -- and those are the official statistics.
Try outpacing those rates with Treasury bills. At present, you'd actually be losing purchasing power by investing in most Treasuries.
When it comes to battling inflation, our only good defense is a good offense. That means keeping an appropriate allocation of your portfolio in equities, even well into retirement.
Note that this Vanguard fund is designed for investors currently in retirement. The further you are from your ideal retirement age, the greater the percentage of your portfolio that should be invested in equities.

Bring inflation to its knees

See, prices will continue to rise for the rest of our lives. Equities give us the best chance to not only keep up with inflation, but even stay ahead of it, in order to increase our purchasing power down the road.

http://www.fool.com/personal-finance/retirement/2008/09/10/this-could-destroy-your-retirement.aspx

Hyperinflation Is U-G-L-Y

Hyperinflation Is U-G-L-Y
By Selena Maranjian January 7, 2009 Comments (1)

Do you know what hyperinflation is? It's what you get when inflation gets way, way out of hand. It's happening in Zimbabwe. In fact, what you can buy with a million Zimbabwean dollars right now might cost you twice as much by the time you finish reading this article. The country's inflation rate is estimated (conservatively, according to some) to be around 230 million percent.

You might buy a loaf of bread with a bill that sports 12 zeros on it. A month later, you'd need to add several more zeros. People are having trouble keeping up. It's causing chaos. And it's not a good environment for investors, either.

Fortunately, we don't have it bad like that. Inflation in America has generally been between 2% and 4% per year. In 1979 and 1980, though, it was around 13%, and it was around 9% in the years before and after that. Let's take 10% as an approximation of how bad we might expect it to get in America for a number of years, and see what that looks like, shall we? Let's start with a $5 sandwich in 2008 and see how the price grows at 10% over a decade:

Year..Price
2009 $5.50
2010 $6.05
2011 $6.66
2012 $7.32
2013 $8.05
2014 $8.86
2015 $9.74
2016 $10.72
2017 $11.79
2018 $12.97

Wow -- the price doubled after only eight years. A $20,000 car in 2008 would cost you nearly $52,000 in 2018! That's a big difference.

Are we in imminent danger of 10% inflation rates? I don't think so -- though inflation rates did recently spike when gas prices were soaring, along with many food prices. These days some are worrying about deflation, although it's not all bad.
Still, a big increase in inflation is often a concern to many, and even now some worry that it might be in our future.

Dangers of inflation

If inflation starts rising, many companies will suffer, and we investors will therefore be affected. We'll be affected as consumers, too. Journalist Robert Samuelson recently described 1979's inflation environment, noting that as prices rose quickly, people couldn't predict costs of everyday items and were concerned that their wages wouldn't keep up. As he put it, "Americans were horrified. ... People couldn't plan; their savings were at risk."

There are signs that prices will stop growing so rapidly in the coming year. Food commodity prices have already fallen. Assuming they keep falling, we'll eventually see prices fall for many grocery items from companies such as Kraft (NYSE: KFT), General Mills (NYSE: GIS), and ConAgra (NYSE: CAG), as well as institutional food services from companies like Sysco (NYSE: SYY). Of course, as the costs of their supplies fall, we shouldn't expect these companies to immediately slash prices. They'll likely amble slowly in their price-cutting, benefiting temporarily from heftier profit margins.

Meanwhile, if gas prices rise again, which isn't unthinkable, that will pressure the entire economy, as it will affect transportation costs for supplies and finished goods. And of course, the transportation companies themselves, such as FedEx (NYSE: FDX), United Parcel Service (NYSE: UPS), and Southwest Airlines (NYSE: LUV), will take a hit.

One way to fight inflation while investing is to seek out dividend-paying companies, which will keep paying you while the economy sorts itself out. Sticking with stocks in inflationary times can protect your retirement.

http://www.fool.com/investing/dividends-income/2009/01/07/hyperinflation-is-ugly.aspx

Thriving In Every Market

Thriving In Every Market
Value Investing Made Easy (Janet Lowe):

1. THRIVING IN EVERY MARKET
2. MR. MARKET
3. SUITABLE SECURITIES AT SUITABLE PRICES
4. PAYING RESPECT TO THE MARKET
5. TIMING VERSUS PRICING
6. BELIEVING A BULL MARKET
7. THE PAUSE AT THE TOP OF THE ROLLER COASTER
8. MAKING FRIENDS WITH A BEAR
9. BARGAINS AT THE BOTTOM
10. SIGNS AT THE BOTTOM
11. BUYING TIME
12. IF YOU ABSOLUTELY MUST PLAY THE HORSES

IF YOU ABSOLUTELY MUST PLAY THE HORSES

IF YOU ABSOLUTELY MUST PLAY THE HORSES

Though Ben Graham in no way recommended trying it, he did say that there is a way to combine market timing and value investing principles. This method was originally developed by Roger Babson, a contemporary of Graham’s who provided financial services and investment counsel. However, Graham noted, the method makes heavy demands on human fortitude, and it can keep an investor out of long stretches of a booming market. It sounds simple. Yet for those who realize how difficult it is to follow, this strategy can diminish the risk of trading on market movements.

Here is the way it works:

1. Select a diversified list of common stocks. (The investor can even create an index fund by buying the DJIA, or better yet, deciding which stocks are undervalued in the DJIA and buying only those.)

2. Determine a normal value for each stock (choose any multiplier of earnings that seems appropriate, using 7- to 10-year average earnings.

3. Buy the stocks when shares can be bought at a substantial discount – say, two-thirds of what the investor has established as normal value. As an alternative to buying at one target price, the investor can start buying as the stock declines, beginning at 80 percent of normal value.

4. Sell the stocks when the price has risen substantially above normal value – say 20 percent to 50 percent higher.

The investor thus would buy in a market decline and sell in a rising market.



THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):

1. THRIVING IN EVERY MARKET
2. MR. MARKET
3. SUITABLE SECURITIES AT SUITABLE PRICES
4. PAYING RESPECT TO THE MARKET
5. TIMING VERSUS PRICING
6. BELIEVING A BULL MARKET
7. THE PAUSE AT THE TOP OF THE ROLLER COASTER
8. MAKING FRIENDS WITH A BEAR
9. BARGAINS AT THE BOTTOM
10. SIGNS AT THE BOTTOM
11. BUYING TIME
12. IF YOU ABSOLUTELY MUST PLAY THE HORSES

BUYING TIME

BUYING TIME

When the market hits its low, true value investors feel that harvest time has arrived. “The most beneficial time to be a vluae investor is when the market is falling,” says investment manager Seth Klarman. There are plenty of companies ripe for the picking. In the summer of 1973, when the stock market had plunged 20 percent in value in less than 2 months, Warren Buffett told a friend, “You know, some days I get up and I want to tap dance.”

Unfortunately, this is the time when investors are feeling most beat up by the markets. Fear and negative thinking prevail, and anyone who has faced down a bear knows how paralyzing fear can be. This, at the depths of a bear market, is the time to buy as many stocks as are affordable. “Value bargains aren’t found in strong markets,” writes money manager Charles Brandes. “A good rule is to examine stock markets that have reacted adversely for a year or so.”

Undervalued stocks quite often lie dormant for months – many months – on end. The only way to anticipate and catch the surge is to identify the undervalued situation, then take a position, and wait, Graham said.

-----
Buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience.
-----



THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):

1. THRIVING IN EVERY MARKET
2. MR. MARKET
3. SUITABLE SECURITIES AT SUITABLE PRICES
4. PAYING RESPECT TO THE MARKET
5. TIMING VERSUS PRICING
6. BELIEVING A BULL MARKET
7. THE PAUSE AT THE TOP OF THE ROLLER COASTER
8. MAKING FRIENDS WITH A BEAR
9. BARGAINS AT THE BOTTOM
10. SIGNS AT THE BOTTOM
11. BUYING TIME
12. IF YOU ABSOLUTELY MUST PLAY THE HORSES

SIGNS AT THE BOTTOM

SIGNS AT THE BOTTOM

The bottom – or near enough the bottom – of a market cycle theoretically should be easier to call than the top or near top. The evidence is found in the corporate balance sheets, income statements, PE ratios, dividend yields, and other quantitative measures. It is likewise reflected in low ratios for the market as a whole. The quantitative factors speak for themselves.

The dividend yield on the Dow Jones Industrial Average, for example, usually cycles between a high yield of 6 percent at the market’s bottom and a low yield of 3 percent at the top. The Dow’s average dividend yield sometimes stretches beyond these boundaries, but historically this is a trustworthy parameter of undervalue and overvalue.



THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):

1. THRIVING IN EVERY MARKET
2. MR. MARKET
3. SUITABLE SECURITIES AT SUITABLE PRICES
4. PAYING RESPECT TO THE MARKET
5. TIMING VERSUS PRICING
6. BELIEVING A BULL MARKET
7. THE PAUSE AT THE TOP OF THE ROLLER COASTER
8. MAKING FRIENDS WITH A BEAR
9. BARGAINS AT THE BOTTOM
10. SIGNS AT THE BOTTOM
11. BUYING TIME
12. IF YOU ABSOLUTELY MUST PLAY THE HORSES

BARGAINS AT THE BOTTOM

BARGAINS AT THE BOTTOM

In 1932 Graham was 38 years old and had already made and lost millions of dollars. To survive the Great Depression he taught at several universities, testified as an expert witness in securities cases, wrote freelance pieces for the financial press, and with his partner, Jerome Newman, bought and liquidated defunct companies.

In June 1942, Forbes published the first in a series of articles written by Graham alerting investors that the shares of many companies were selling at prices below the value of the actual cash held in the company vaults. The series was called “Is American Business Worth More Dead Than Alive?”

Graham pointed out that 30 percent of the companies listed on the NYSE were selling at less than their net working capital, with some going for less than their cash assets. In other words, if an investor bought all the shares of a company, then sold off its assets, he would reap considerable profits. That series of articles was widely read. It gave dispirited investors the courage to return to the stock market and spurred a long, sustained recovery.

Graham’s wisdom inspired investors again in 1974, when the stock market was in a deep depression. He addressed the annual meeting of the Institute of Chartered Financial Analysts (which he helped found), the predecessor to the Association for Investment Management and Research (AIMR). In a speech entitled “A Renaissance of Value,” Graham pointed out that once more, stocks were selling at deep discounts to their intrinsic value. “How long will such “fire-sale stocks” continue to be given away?” he asked. Graham encouraged the investment managers to buy as many bargain issues as possible while prices were low. The Dow, at the time, had receded to 600.

Again, Graham sounded the wake-up call that led to a market revival. By 1976 the DJIA topped 900.



THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):

1. THRIVING IN EVERY MARKET
2. MR. MARKET
3. SUITABLE SECURITIES AT SUITABLE PRICES
4. PAYING RESPECT TO THE MARKET
5. TIMING VERSUS PRICING
6. BELIEVING A BULL MARKET
7. THE PAUSE AT THE TOP OF THE ROLLER COASTER
8. MAKING FRIENDS WITH A BEAR
9. BARGAINS AT THE BOTTOM
10. SIGNS AT THE BOTTOM
11. BUYING TIME
12. IF YOU ABSOLUTELY MUST PLAY THE HORSES

MAKING FRIENDS WITH A BEAR

MAKING FRIENDS WITH A BEAR

When corrections come quickly, the question always arises: Is this a repeat of 1929? Will brokers be jumping out of windows? Is this the start of another Great Depression? Certainly Graham knew about such experiences.

Though he realized the 1929 stock market was on dangerously high ground, he’d chosen his investments carefully and hedged his accounts. Graham believed he’d protected his accounts, yet he’d failed to fully execute all his hedges and he’d overused margin. His accounts were badly damaged by the crash. Nevertheless, he hung in, rebuilt his portfolio, and soon afterward triggered a market recovery by telling the world that the time to resume buying had arrived.



THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):

1. THRIVING IN EVERY MARKET
2. MR. MARKET
3. SUITABLE SECURITIES AT SUITABLE PRICES
4. PAYING RESPECT TO THE MARKET
5. TIMING VERSUS PRICING
6. BELIEVING A BULL MARKET
7. THE PAUSE AT THE TOP OF THE ROLLER COASTER
8. MAKING FRIENDS WITH A BEAR
9. BARGAINS AT THE BOTTOM
10. SIGNS AT THE BOTTOM
11. BUYING TIME
12. IF YOU ABSOLUTELY MUST PLAY THE HORSES

THE PAUSE AT THE TOP OF THE ROLLER COASTER

THE PAUSE AT THE TOP OF THE ROLLER COASTER

There is only one strategy that works for value investors when the market is high – patience. The investor can do one of two things, both of which require steady nerves.

· Sell all stocks in a portfolio, take profits, and wait for the market to decline. At that time, many good values will present themselves. This may sound easy, but it pains many investors to sell a stock when its price is still rising.

· Stick with those stocks in a portfolio that have long-term potential. Sell only those that are clearly overvalued, and once more wait for the market to decline. At this time, value stocks may be appreciating at slow pace compared with the frisky growth stocks, but not always.

But come the correction, be it sudden or slow, the well-chosen value stocks have a better chance of holding their price.

The portfolio of one value investor shows what can happen when markets stumble off a cliff. In early September 1987, Walter Schloss’s portfolio was up 53%. The market as a whole had risen 42%, after a DJIA peak of 2722.42. Then in October the market fell off the mountain and the Dow lost 504 points in a single day. The market struggled back and Schloss finished 1987 with a 26% gain while the overall market made only a 5% advance. Schloss followed one of the first rules of investing – don’t lose money. Making up for lost ground puts an investor at a serious disadvantage when calculating long-term average returns.

Schloss is an experienced investor, and not all value investors will do as well in a rising market. It takes patience, “At a guess I’d say that (the value investor) should do a good 20% better than the market over a long period – although not during the most dynamic period of a bull market – if he is rigorous about applying the method,” says author John Train.

As for the hot stocks, when they take a hard hit the investor is cornered. If the stock is sold, the loss becomes permanent. The lost money cannot grow. If the investor hangs on to the deflated stock, the long trail back to the original purchase price will deeply erode the overall return.



THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):

1. THRIVING IN EVERY MARKET
2. MR. MARKET
3. SUITABLE SECURITIES AT SUITABLE PRICES
4. PAYING RESPECT TO THE MARKET
5. TIMING VERSUS PRICING
6. BELIEVING A BULL MARKET
7. THE PAUSE AT THE TOP OF THE ROLLER COASTER
8. MAKING FRIENDS WITH A BEAR
9. BARGAINS AT THE BOTTOM
10. SIGNS AT THE BOTTOM
11. BUYING TIME
12. IF YOU ABSOLUTELY MUST PLAY THE HORSES