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http://www.topyields.nl/Top-dividend-yields-of-KLCI30.phpKeep INVESTING Simple and Safe (KISS) ****Investment Philosophy, Strategy and various Valuation Methods**** The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
Monday 23 April 2012
Sunday 22 April 2012
Who is a Value Investor?
Morningstar is a widely used source of mutual fund information, and it
categorized 38 percent of mutual funds as value funds in 2001. But how
did it make this categorization? While it did look at the way these funds
described themselves in their prospectus, the ultimate categorization was
based on a far simpler measure. Any fund that invested in stocks with low
price-to-book value ratios or low price earnings ratios, relative to the market, was categorized as a value fund. This categorization is fairly conventional, but we believe that it is too narrow a definition and misses the
essence of value investing.
Another widely used definition of value investors suggests that they are investors interested in buying stocks for less than what they are worth. But that is too broad a definition, because you could potentially categorize most active investors as value investors on this basis. After all, growth investors (who are often viewed as competing with value investors) also want to buy stocks for less than what they are worth.
So, what is the essence of value investing? To understand value investing, we have to begin with the proposition that the value of a firm is derived from two sources—
Even with this definition of value investing, there are three distinct strands that we see in value investing.
Another widely used definition of value investors suggests that they are investors interested in buying stocks for less than what they are worth. But that is too broad a definition, because you could potentially categorize most active investors as value investors on this basis. After all, growth investors (who are often viewed as competing with value investors) also want to buy stocks for less than what they are worth.
So, what is the essence of value investing? To understand value investing, we have to begin with the proposition that the value of a firm is derived from two sources—
- investments that the firm has already made (assets in place) and
- expected future investments (growth opportunities).
Even with this definition of value investing, there are three distinct strands that we see in value investing.
- The first and perhaps simplest form of value investing is passive screening, where companies are put through a number of investment screens—for example, low PE ratios, marketability, and low risk—and those that pass the screens are categorized as good investments.
- In its second form, you have contrarian value investing, where you buy assets that are viewed as untouchable by other investors because of poor past performance or bad news about them.
- In its third form, you become an activist value investor who buys equity in undervalued or poorly managed companies but then uses the power of your position (which has to be a significant one) to push for change that will unlock this value.
3 Stages of a Bull Market and 3 Stages of a Bear Market
2011 Value Investing Congress Notes
http://www.scribd.com/doc/54958483/2011-Value-Investing-Congress-Notes
o Constantly going between greed and fear, risk tolerance and risk aversion, and optimism and pessimism
o In theory, the pendulum should be at the happy medium
On average it is in the middle
But it spends little time there
Excesses constitute the errors of herd behavior
3 stages of a bull market
Few people feel things are getting better
Most people realize improvement is taking place
Everyone thinks things will get better forever
"What the wise man does in the beginning, the fool does in the end."
o The last buyer pays the price
3 stages of a bear market
Few people realize that things are overpriced and dangerous
Most people see the decline is underway
Everyone believes that things will get worse forever
o Great opportunity to buy if we can behave counter-cyclically - Importance of being a contrarian.
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/
Assessing Buffett. Is Warren Buffett worthy of his reputation?
It might be presumptuous of us to assess an investor who has acquired mythic status, but is Warren Buffett worthy of his reputation? If so, what accounts for his success, and can it be replicated? We believe that
his reputation is well deserved and that his extended run of success cannot be attributed to luck. While he has had his bad years, he has always bounced back in subsequent years. The secret to his success seems to rest on the long view he brings to companies and his discipline—the unwillingness to change investment philosophies even in the midst of short-term failure.
Much has been made of the fact that Buffett was a student of Graham at Columbia University and their adherence to value investing. Warren Buffett’s investment strategy is more complex than Graham’s original passive screening approach. Unlike Graham, whose investment strategy was inherently conservative, Buffett’s strategy seems to extend across a far more diverse range of companies, from high-growth firms like Coca-Cola to staid firms such as Blue Chip Stamps. While Graham and Buffett both might use screens to find stocks, the key difference as we see it between the two men is that Graham strictly adhered to quantitative screens whereas Buffett has been more willing to consider qualitative screens. For instance, Buffett has always put a significant weight on both the credibility and the competence of top managers when investing in a company.
In more recent years, he has had to struggle with two byproducts of his success.
- Buffett’s record of picking winners has attracted a crowd of imitators who follow his every move and buy everything be buys, making it difficult for him to accumulate large positions at attractive prices.
- At the same time, the larger funds at his disposal imply that he is investing far more than he did two or three decades ago in each of the companies that he takes a position in, which makes it more difficult for him to be a passive investor. It should come as no surprise, therefore, that he is a much more activist investor than he used to be, serving on boards of The Washington Post and other companies and even operating as interim chairman of Salomon Brothers during the early 1990s
BUFFETT'S TENETS
Roger Lowenstein, in his excellent book on Buffett, suggests that Buffett’s success can be traced to his adherence to the basic notion that when you buy a stock, you are buying an underlying business.
Business Tenets:
The business the company is in should be simple and understandable. In fact, one of the few critiques of Buffett was his refusal to buy technology companies, whose business he said was difficult to understand.
The firm should have a consistent operating history, manifested in operating earnings that are stable and predictable.
The firm should be in a business with favorable long-term prospects.
Management Tenets:
The managers of the company should be candid. As evidenced by the way he treated his own stockholders, Buffett put a premium on managers he trusted. Part of the reason he made an investment in The Washington Post was the high regard that he had for Katherine Graham, who inherited the paper from her husband.
The managers of the company should be leaders and not followers. In practical terms, Buffett was looking for companies that mapped out their own long-term strategies rather than imitating other firms.
Financial Tenets:
The company should have a high return on equity, but rather than base the return on equity on accounting net income, Buffett used a modified version of what he called owner earnings:
Owner Earnings Net income Depreciation and Amortization – Capital Expenditures
This concept is very close to a free cash flow to equity.
The company should have high and stable profit margins and a history of creating value for its stockholders.
Market Tenets:
In determining value, much has been made of Buffett’s use of a risk-free rate to discount cash flows. Because he is known to use conservative estimates of earnings and because the firms he invests in tend to be stable firms, it looks to us like he makes his risk adjustment in the cash flows rather than the discount rate.
In keeping with Buffett’s views of Mr. Market as capricious and moody, even valuable companies can be bought at attractive prices when investors turn away from them.
http://media.wiley.com/product_data/excerpt/32/04713450/0471345032.pdf
Benjamin Graham and his 9 commandments of value investing
GRAHAM'S MAXIMS ON INVESTING
Janet Lowe, in her biography of Ben Graham, notes that while his lectures were based upon practical examples, he had a series of maxims that he emphasized on investing. Because these maxims can be viewed as the equivalent of the 10 commandments of value investing, they are worth revisiting:
1. Be an investor, not a speculator. Graham believed that investors bought companies for the long term, but speculators looked for short-term profits.
2. Know the asking price. Even the best company can be a poor investment at the wrong (too high) price.
3. Rake the market for bargains. Markets make mistakes.
4. Stay disciplined and buy the formula:
E (2g + 8.5) (T.Bond rate/Y)
where E = Earnings per share, g = Expected growth rate in earnings, Y is the yield on AAA-rated corporate bonds, and 8.5 is the appropriate multiple for a firm with no growth.
For example, consider a stock with $2 in earnings in 2002 and 10 percent growth rate when the Treasury bond rate was 5 percent and the AAA bond rate was 6 percent. The formula would have yielded the following price:
Price = $2.00 (2 (10)+8.5)* (5/6) = $47.5
If the stock traded at less than this price, you would buy the stock.
5. Regard corporate figures with suspicion (advice that carries resonance in the aftermath of recent accounting scandals).
6. Diversify. Do not bet it all on one or a few stocks.
7. When in doubt, stick to quality.
8. Defend your shareholder’s rights. This topic was another issue on which Graham was ahead of his time. He was one of the first advocates of strong corporate governance.
9. Be patient. This follows directly from the first maxim.
It was Ben Graham who created the figure of Mr. Market, which was later much referenced by Warren Buffett. As described by Mr. Graham, Mr. Market was a manic-depressive who did not mind being ignored and was there to serve and not to lead you. Investors, he argued, could take advantage of Mr. Market’s volatile disposition to make money.
http://media.wiley.com/product_data/excerpt/32/04713450/0471345032.pdf
Benjamin Graham: The Father of Screening
Many value investors claim to trace their antecedents to Ben Graham and to use the book on security analysis that he co-authored with David Dodd in 1934 as their investment bible. But who was Ben Graham, and what were his views on investing? Did he invent screening, and do his screens still work?
Graham’s Screens
Ben Graham started life as a financial analyst and later was part of an investment partnership on Wall Street. While he was successful on both counts, his reputation was made in the classroom. He taught at Columbia and the New York Institute of Finance for more than three decades and during that period developed a loyal following among his students. In fact, much of Mr. Graham’s fame comes from the success enjoyed by his students in the market.
It was in the first edition of Security Analysis that Ben Graham put his mind to converting his views on markets to specific screens that could be used to find undervalued stocks. While the numbers in the screens did change slightly from edition to edition, they preserved their original form and are as follows:
1. Earnings to price ratio that is double the AAA bond yield
2. PE of the stock has to be less than 40 percent of the average PE for all stocks over the past five years
3. Dividend Yield > Two-thirds of the AAA Corporate Bond Yield
4. Price < Two-thirds of Tangible Book Value1
5. Price < Two-thirds of Net Current Asset Value (NCAV), where net current asset value is defined as liquid current assets including cash minus current liabilities
6. Debt-Equity Ratio (Book Value) has to be less than one
7. Current Assets > Twice Current Liabilities
8. Debt < Twice Net Current Assets
9. Historical Growth in EPS (over last 10 years) > 7%
10. No more than two years of declining earnings over the previous 10 years
Tangible book value is computed by subtracting the value of intangible assets, such as goodwill, from the total book value.
Any stock that passes all 10 screens, Graham argued, would make a worthwhile investment. It is worth noting that while there have been a number of screens that have been developed by practitioners since these first appeared, many of them are derived from or are subsets of these original screens.
The Performance
How well do Ben Graham’s screens work when it comes to picking stocks?
- Henry Oppenheimer studied the portfolios obtained from these screens from 1974 to 1981 and concluded that you could have made an annual return well in excess of the market.
- As we will see later in this section, academics have tested individual screens—low PE ratios and high dividend yields to name two—in recent years and have found that they indeed yield portfolios that deliver higher returns.
- Mark Hulbert, who evaluates the performance of investment newsletters, found newsletters that espoused to follow Graham did much better than other newsletters.
http://media.wiley.com/product_data/excerpt/32/04713450/0471345032.pdf
Value Investing - Key Points
Value investors are bargain hunters and many investors describe themselves as such. But who is a value investor? We argue that value investors come in many forms.
- Some value investors use specific criteria to screen for what they categorize as undervalued stocks and invest in these stocks for the long term.
- Other value investors believe that bargains are best found in the aftermath of a sell-off and that the best time to buy a stock is when it is down.
- Still others adopt a more activist approach, where they buy large stakes in companies that they believe are undervalued and push for changes that they believe will unleash this value.
Value investing is backed by empirical evidence from financial theorists and by anecdotal evidence—the success of value investors like Ben Graham and Warren Buffett are part of investment mythology—but it is
not for all investors. Investors need to consider what they bring to the table to succeed at value investing.
http://media.wiley.com/product_data/excerpt/32/04713450/0471345032.pdf
Lessons for Value Investors
To be a value investor, you should have:
- A long-time horizon: While the empirical evidence is strongly supportive of the long-term success of value investing, the key word is long term. If you have a time horizon that is less than two or three years, you might never see the promised rewards to value investing.
- Be willing to bear risk: Contrary to popular opinion, value investing strategies can entail a great deal of risk. Firms that look cheap on a price to earnings or price to book basis can be exposed to both earnings volatility and default risk.
In addition to these, to be a contrarian value investor, you need:
- A tolerance for bad news: As a contrarian investor who buys stocks that are down and out, you should be ready for more bad news to come out about these stocks. In other words, things will often get worse before they get better.
In addition to all of the above, to be an activist investor, you have to:
- Be willing to fight: Incumbent managers in companies that you are trying to change will seldom give in without a fight.
http://media.wiley.com/product_data/excerpt/32/04713450/0471345032.pdf
http://myinvestingnotes.blogspot.com/2009/03/nearly-50-of-all-us-stocks-trading-for.html
Nearly 50% of all US stocks trading for less than $5 per share (6.3.2009)
http://myinvestingnotes.blogspot.com/2009/03/nearly-50-of-all-us-stocks-trading-for.html
Friday 20 April 2012
Basic Options Concepts: Intrinsic Value and Time Value
Intrinsic value and time value are two of the primary determinants of an option's price.
Call Options: Intrinsic value = Underlying Stock's Current Price - Call Strike Price Time Value = Call Premium - Intrinsic Value
Put Options: Intrinsic value = Put Strike Price - Underlying Stock's Current Price Time Value = Put Premium - Intrinsic Value
ATM and OTM options don't have any intrinsic value because they do not have any real value. You are simply buying time value, which decreases as an option approaches expiration.
The intrinsic value of an option is not dependent on the time left until expiration. It is simply an option's minimum value; it tells you the minimum amount an option is worth.
On the expiration day, all an option is worth is its intrinsic value. It's either in-the-money, or it isn't.
http://biz.yahoo.com/opt/basics5.html
Intrinsic value can be defined as the amount by which the strike price of an option is in-the-money. It is actually the portion of an option's price that is not lost due to the passage of time.
The following equations will allow you to calculate the intrinsic value of call and put options:
Call Options: Intrinsic value = Underlying Stock's Current Price - Call Strike Price Time Value = Call Premium - Intrinsic Value
Put Options: Intrinsic value = Put Strike Price - Underlying Stock's Current Price Time Value = Put Premium - Intrinsic Value
ATM and OTM options don't have any intrinsic value because they do not have any real value. You are simply buying time value, which decreases as an option approaches expiration.
The intrinsic value of an option is not dependent on the time left until expiration. It is simply an option's minimum value; it tells you the minimum amount an option is worth.
Time value is the amount by which the price of an option exceeds its intrinsic value. Also referred to as extrinsic value, time value decays over time. In other words, the time value of an option is directly related to how much time an option has until expiration.
- The more time an option has until expiration, the greater the option's chance of ending up in-the-money.
- Time value has a snowball effect.
- If you have ever bought options, you may have noticed that at a certain point close to expiration, the market seems to stop moving anywhere.
- That's because option prices are exponential-the closer you get to expiration, the more money you're going to lose if the market doesn't move.
On the expiration day, all an option is worth is its intrinsic value. It's either in-the-money, or it isn't.
http://biz.yahoo.com/opt/basics5.html
How is Option Priced?
There are 6 factors that affect option's price. Nevertheless, the impact of interest rate and dividend are often considered negligible as compared to the other factors. Most of the time, for each level of strike price, an option's price will move due to the movement of underlying stock price, volatility and time.
The Black-Scholes formula can be used to calculate the theoretical value of an option based on the above factors.
Since option's buyers (long position) will profit when the option price rises after they buy (Buy Low, Sell High), whereas the seller (short position) will profit when the option price falls after they sell (Sell High, Buy Low), the impact of the above factors will also be different.
The following table shows how the major factors (stock price, time to expiration, implied volatility) affect an option's position.
Example:
Increase in Implied Volatility (IV) would increase option's price (both calls & puts), assuming other factors unchanged. Hence, this will be favorable for option buyers who will gain if the option price increases (buy low, sell high), but unfavorable for option sellers that will profit if the option price drops (sell high, buy low).
http://optionstradingbeginner.blogspot.com/2007/05/option-pricing-how-is-option-priced_22.html
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