Picking Stocks Like Peter Lynch

Back to Basics: Investing Like Benjamin Graham

Income Investing - The Power of Dividends

What is capitulation?

What is capitulation? CNBC Explains

Traditionally, the word capitulation describes a surrender between fighting armies. What is capitulation when it's used on Wall Street? What does it signify? We explain.

What is capitulation?

In simple terms, capitulation is when investors try to get out of the stock market as quickly as possibleand look for less risky investments. It's also described as panic selling. It's usually based on investor fears that stock prices will fall further than they have.

Capitulation is usually signaled by a decline in the markets of at least 10% in one day.

In getting out of the market, investors give up any previous gains in stock price. That means they take a financial loss, just to get out of stocks. The thinking is: take a smaller loss now rather than a bigger one later.

Real capitulation involves extremely high volume-or high numbers of traded shares-and sharp declines in stock prices.

Why do investors capitulate?

Suppose a stock starts dropping in price. There are two choices. Investors stick it out and hope the stock begins to appreciate-or they can take the loss by selling the stock.

If the majority of investors decide to wait it out, then the stock price will probably remain stable. But if the majority of investors decide to capitulate and give up on a stock, they start selling and that starts a sharp decline in a stock's price.

Are there any benefits from capitulation?

Only for those buyers ready to swoop in. After capitulation selling, common wisdom has it that there are great bargains to be had in the stock market. Why? Because everyone who wants to get out of a stock, for any reason, has sold it. The price should then, theoretically, reverse or bounce off the lowest price of the stock.

In other words, some investors believe that capitulation is the sign of a bottom and a chance to get stocks at a cheaper price than before the capitulation took place.

Is capitulation a way to gauge the markets?

Not at all.Capitulation is very difficult to forecast and use as a way to buy or sell stocks. There is no magical price at which capitulation takes place. Certainly during the trading day, stock prices and volumes are monitored and some measurement is used to determine if a capitulation is taking place and will remain so at the end of the day.

But most often, investors and market watchers look back to determine when the markets actually capitulated and see how far stocks have fallen in price for that one day of trading.

When have there been capitulations?

The stock market crash of 1929 that helped lead to the Great Depression, is a capitulation. In fact, it had more than one day of it.

On Oct. 24, 1929-what's known as Black Thursday-share prices on the New York Stock Exchange collapsed. A then-record number of 12.9 million shares was traded.

But more was to follow. Oct. 28, the first "Black Monday," more investors decided to get out of the market, and the slide continued with a record loss in the Dow for the day of 38 points, or 13 percent.

The next day, "Black Tuesday," Oct. 29, 1929, about 16 million shares were traded, and the Dow lost an additional 30 points.

More recently, there was a massive sell off or panic selling of stocks on Oct. 10, 2008, in what can be considered a capitulation. Not only U.S. stocks, but global markets had major declines of 10 percent or more on one day.

Investors flooded exchanges with sell orders, dragging all benchmarks sharply lower. It's believed fears of a global recession and the U.S. housing slump sparked the sell-off.

Slow and steady doesn't make headlines, but the company can continue to earn excellent returns on invested capital.

CTB operates worldwide in the agriculture equipment field.  Berkshire purchased it in 2002 and by 2009, it has picked up six small firms.

Berkshire paid $140 million for the company.  In 2008, its pre-tax earnings were $89 million.

Vic Mancinellis, CEO of CTB, an agricultural equipment company, one of Berkshire's boring manufacturing businesses, exemplifies another reason for optimism.

Since Buffett bought CTB in 2002, it has earned roughly an average 11 percent annual return, compared to the S&P return of only 3 percent.

How can such a basic business produce eye-popping results?

It wasn't through financial innovations or game-changing acquisitions.   Instead, Mancinelli focussed on "blocking and tackling, day by day doing the little things right and never getting off course:"

Ten years from now, Vic will be running a much larger operation and, more important, will be earning excellent returns on invested capital.

But slow and steady doesn't make headlines.  Investors approaching the stock market continue to put their money in the hare, not the tortoise.

Betting on tortoises can create long-lasting wealth.

Goodwill. Understand the "cost" of goodwill.

Goodwill is an accounting term that describes the dollars paid to buy a business over and above its book value.  Goodwill is a real number, but it tells us nothing about the future earning power of a business.

Berkshire owns some terrific businesses.  Many of them were purchased, however, at large premiums to net worth - point reflected in the good will item shown in its balance sheet.  In year 2008, its balance sheet reported a goodwill of US 16,515 millions.  The company earned an impressive 17.9% on average tangible net worth in 2008, but if goodwill was included, this reduced the earnings to 8.1%.

Buffett paid more for these businesses because he expects them to earn gobs of money in the future.  In this happy event, the goodwill number is not relevant.

However, if increased earnings don't materialize, the amount of goodwill will weigh on the earnings of a business.  How will this affect investor returns?

By including the amount paid for goodwill in the return calculation, Buffett clearly reports the "cost" of goodwill.

In 2008, Berkshire investors got a return of only 8.1% on their total net worth, including goodwill, compared to a return of 17.9% on tangible net worth, excluding goodwill.

Most large U.S. companies have large amounts of goodwill reported on their balance sheets.  This information is important to know.  If companies pay more for acquisitions than the future earnings these ventures produce, investors will be harmed.

Ignore the noises that rattle the markets. A conclusion about the economy does not tell us if the stock market will rise or fall.

In 75% of those years (from 1965 to 2008), the S&P stocks recorded a gain.   You can guess that a roughly similar percentage of years will be positive in the future too.Can you predict the winning and losing years in advance?  I don't think anyone can.

The economy was in shambles throughout 2009, but that did not tell us whether the stock market will rise or fall.

A conclusion about the economy does not tell us if the stock market will rise or fall.

Understand accounting allows you to understand how companies create value.

To better understand the wealth-producing advantages of the businesses, you have to understand accounting and the "vastly different" financial reporting characteristics of various businesses.

Accounting, just like eating spinach, may not be what you want, but it sure is good for you.  :-)

A little patience brings great rewards.  You can learn something important about each business and can also use your knowledge to understand how other companies create value.

You want to be informed, confident and loyal in your investing.

Buffett: See's Candies - A Great, Not Just a Good, Business

Buffet never forgets that growth is good, but only at a reasonable cost.

In 2007, See's Candies sold 31 million pounds of chocolate, a growth rate of only 2 percent.  What does Buffett see that other misses?

1.  He paid a sensible price for the business.
2.  The company enjoys a durable competitive advantage:  Its quality chocolate is bought by legions of loyal customers.
3.  It is a business he understands.
4.  It has great managers.

But See's Candies possesses one more attraction.  It throws off cash and requires very little capital to grow. 

Here is Buffett explaining See's value proposition in his 2007 shareholder letter:

" We bought See's [in 1972] for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million.  The capital then required to conduct the business was $8 million.  (Modest seasonal debt was also needed for a few months each year.)  Consequently, the company was earning 60% pre-tax on invested capital.  Two factors helped to minimize the funds required for operations.  First, the product was sold for cash, and that eliminated accounts receivable.  Second, the production and distribution cycle was short, which minimized inventories.

Last year See's sales were $383 million, and pre-tax profits were $82 million.  The capital now required to run the business is $40 million.  This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth - and somewhat immodest financial growth - of the business.  In the meantime pre-tax earnings have totalled $1.35 billion.  all of that, except for the $32 million, has been sent to Berkshire."

Buffett uses See's cash to buy other attractive businesses. 

"Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us.  (The biblical command to "be fruitful and multiply" is one we take seriously at Berkshire.) .. There's no rule that you have to invest money where you've earned it.  Indeed, it's often a mistake to do so:  Truly great businesses, earning huge returns on tangible assets, can't for any extended period reinvest a large portion of their earnings internally at high rates of return."

But a company like slow-growing See's is rare in corporate America.  In order to grow earnings like See's, CEOs in other businesses typically would need "to invest $400 million, not the $32 million" that See's required.  Why is this true?  Because most growing businesses "have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments."  Not so at See's.

Buffett opines that the great business, like See's, is like a savings account that "pays an extraordinarily high interest rate that will rise as the years pass." 

See's is not just the candy.  To Buffett, the company is a chocolate-powered cash machine.



Additional notes:  Great, Good and Gruesome Businesses of Buffett

Capital Allocation and Savings Accounts

Buffett compares his three different types of great, good and gruesome businesses to "savings accounts." 

The great business is like an account that pays an extraordinarily high interest rate that will rise as the years pass.

A good one pays an attractive rate of interest that will be earned also on deposits that are added.

The gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

Bill Gross: Financial markets are artificially priced. Discounting of future profit streams by an artificially low interest rate results in corresponding high P/E ratios. Real estates are affected in the same way.

Financial markets are artificially priced. In the bond market, there is nothing normal about a three year German Bund yielding a “minus” 10 basis points. Similarly, UK Gilts and U.S. Treasurys have in recent years never experienced such low yields and therefore high prices. The same comparison can be applied to stocks. While profits in many cases are at record highs, the discounting of future profit streams by an artificially low interest rate results in corresponding high P/E ratios. Real estate cap rates, which help to price homes and commercial shopping centers, are affected in the same way. While monetary policy with its Quantitative Easing and forward guidance for low future interest rates have salvaged a semblance of growth and job gains – especially in the U.S. – they have brought prosperity forward in the financial markets. If yields can’t go much lower, then bond market capital gains are limited. The same logic applies in other asset categories. We have had our Biblical seven years of fat. We must look forward, almost by mathematical necessity, to seven figurative years of leaner: Bonds – 3% to 4% at best, stocks – 5% to 6% on the outside. That may not be enough for your retirement or your kid’s college education. It certainly isn’t for many private and public pension funds that still have a fairy tale belief in an average 7% to 8% return for the next 10 to 20 years! What do you do?

Well the obvious advice on a personal level: Retire later, save more, accept a revised standard of living. But the financial advice varies with your age and willingness to take risk. Younger investors with a Texas Hold’em “all in” attitude could push all of their chips onto the equity table. Boomers nearing retirement probably cannot afford to. A lengthy bear market could force them permanently out of the game. So, one size does not fit all here. It never has.

What might be applicable for most generations, however, is an “unconstrained strategy” that I managed well for the past few years at PIMCO and which now provides me the opportunity for 100% of my time at Janus. An unconstrained strategy sounds very open-ended, and it is. But it allows a professional and experienced investment firm like Janus to select the most attractive alternatives across many asset categories while hopefully diminishing the risk of bond and stock bear markets. The strategy seeks to protect principal while providing an acceptable return in this low yielding, low returning world that I have just described. Unconstrained investors should expect a shorter average maturity for bonds; an ability to profit from currency movements currently taking place with the euro and the yen fits the description as well; taking advantage of what is known as “optionality” and investing in what I have successfully applied in the past with what is called “structured alpha,” would be an important component too. The simple explanation of an unconstrained strategy:

Take your best ideas within the context of a low duration/short maturity portfolio and try to help investors achieve what they consider to be an acceptable return. Watch the fees as well.

Whatever your risk/return persuasion, whether it be stocks, bonds, unconstrained, real estate, or “other,” an “intelligent investor” (as initially described by Benjamin Graham in the late 1940s) should be aware that returns almost necessarily cannot equal the magnificent prior decades that some of you might have experienced during my days at PIMCO. But I/we look forward, with the same intensity and “client comes first” attitude that led to my second marriage at Janus. James Bond famously said that “you only live twice.” I hope to emulate Mr. Bond as Janus Denver and Janus Newport Beach link hands and ideas to improve your financial balance sheet, and ultimately provide a better life for you and your family. Perhaps you only dance twice too. Sue and I would like that.

https://finance.yahoo.com/news/bill-gross-only-dance-twice-153815259.html

24 of the most profitable companies return an average of 573% in a decade

It might seem simple, but if you pick stocks based on earnings, you will be a winner

Bloomberg News/Landov Gilead Sciences (CEO John C. Martin) has been the most profitable of S&P 1500 member companies in health care over the past six months. Its stock has returned 431% in three years. 

 

The best-run companies tend to have the widest profit margins. So how does that translate into stock-price performance?

 

The short answer is that they are superior bets.

 

But first, there are several types of profit margins. For example, the gross margin is the difference between net sales and the cost of sales, divided by net sales. That measures the profitability of a company's core business, leaving out general expenses, interest, depreciation, taxes, amortization and other items. It is a useful measure to track companies' progress over time.

 

A conglomerate such as General Electric Co. (GE) will report an €œindustrial margin, which excludes its financial business, and will even break down a separate margin for each of its lines of business.

 

Depending on the sector or industry, certain margin measures may not be available. But the net income margin is net income divided net sales or revenue is a common measure available for every profitable company.

 

So we developed a list of highly profitable companies, using components of the S&P 1500. We picked the top three in the 10 broad market sectors by net income margin over the past 12 months, as calculated by FactSet.

 

Here they are, with the sectors in alphabetical order:
 

 

Most profitable S&P 1500 companies across 10 sectors

Company Ticker Location Sector Net income margin - past 12 months

   

PulteGroup Inc. (PHM) Bloomfield Hills, Mich. Consumer Discretionary 46.50%

Iconix Brand Group Inc. (ICON) New York Consumer Discretionary 36.10%

Priceline Group Inc. (PCLN) Norwalk, Conn. Consumer Discretionary 27.96%

 

Philip Morris International Inc. (PM) New York Consumer Staples 26.60%

Altria Group Inc. (MO) Richmond, Va. Consumer Staples 24.31%

Brown-Forman Corp. Class B (BF-B) Louisville, Ky. Consumer Staples 22.12%

 

Gulfport Energy Corp. (GPOR) Oklahoma City Energy 51.83%

Approach Resources Inc. (AREX) Forth Worth, Texas Energy 30.05%

Atwood Oceanics Inc. (ATW) Houston Energy 28.92%

 

Capstead Mortgage Corp. (CMO) Dallas Financials 76.49%

LTC Properties Inc. (LTC) Westlake Village, Calif. Financials 56.54%

RenaissanceRe Holdings Ltd. (RNR) Pembroke, Bermuda Financials 54.02%

 

Gilead Sciences Inc. (GILD) Foster City, Calif. Health Care 42.64%

Anika Therapeutics Inc. (ANIK) Bedford, Mass. Health Care 36.20%

Edwards Lifesciences Corp. (EW) Irvine, Calif. Health Care 35.70%

 

Delta Air Lines Inc. (DAL) Atlanta Industrials 27.84%

Union Pacific Corp. (UNP) Omaha, Neb. Industrials 20.58%

ITT Corp. (ITT) White Plains, N.Y. Industrials 19.81%

 

Verisign Inc. (VRSN) Reston, Va. Information Technology 57.43%

Visa Inc. Class A (XNYS:V) Foster City, Calif. Information Technology 44.65%

MasterCard Inc. Class A (MA) Purchase, N.Y. Information Technology 37.14%

 

CF Industries Holdings Inc. (CF) Deerfield, Ill. Materials 31.44%

Royal Gold Inc. (RGLD) Denver Materials 26.41%

Sigma-Aldrich Corp. (SIAL) St. Louis Materials 18.59%

 

AT&T Inc. (XNYS:T) Dallas Telecommunications 13.75%

Verizon Communications Inc. (VZ) New York Telecommunications 12.50%

Atlantic Tele-Network Inc. (ATNI)   Beverly, Mass. Telecommunications 11.78%

 

Aqua America Inc. (WTR) Bryn Mawr, Pa. Utilities 26.92%

OGE Energy Corp. (OGE)   Oklahoma City Utilities 17.59%

Questar Corp. (STR) Salt Lake City Utilities 14.46%

 

Source: FactSet

 
 

A look at total returns (through Tuesday) for those groups of companies tells an interesting story:

 

Total returns 

Company Ticker Total return -   YTD Total return - 3 Years Total return - 5 years Total return - 10 years

 

PulteGroup Inc. PHM -10% 359% 83% -25%

Iconix Brand Group Inc. ICON -8% 135% 204% 785%

Priceline Group Inc. PCLN -5% 137% 537% 4,878%
 

Philip Morris International Inc. PM 0% 46% 109%

N/A Altria Group Inc. MO 24% 96% 244% 627%

Brown-Forman Corp. Class B BF.B 17% 103% 217% 382%
 

Gulfport Energy Corp. GPOR -22% 108% 481% 1,186%

Approach Resources Inc. AREX -31% -28% 47%

N/A Atwood Oceanics Inc. ATW -21% 18% 18% 225%
 

Capstead Mortgage Corp. CMO 11% 50% 63% 181%

LTC Properties Inc. LTC 10% 73% 107% 277%

RenaissanceRe Holdings Ltd. RNR 3% 66% 89% 130%
 

Gilead Sciences Inc. GILD 39% 431% 360% 997%

Anika Therapeutics Inc. ANIK -2% 505% 490% 156%

Edwards Lifesciences Corp. EW 61% 47% 207% 531%
 

Delta Air Lines Inc. DAL 29% 357% 331%

N/A Union Pacific Corp. UNP 28% 155% 300% 729%

ITT Corp. ITT -1% 209% 182% 268%
 

Verisign Inc. VRSN -8% 85% 171% 206%

Visa Inc. Class A V -6% 147% 205%

N/A MasterCard Inc. Class A MA -12% 137% 252%
 

N/A CF Industries Holdings Inc. CF 23% 118% 238%

N/A Royal Gold Inc. RGLD 39% 4% 40% 329%

Sigma-Aldrich Corp. SIAL 45% 124% 168% 432%
 

AT&T Inc. T 4% 43% 76% 119%

Verizon Communications Inc. VZ 4% 56% 130% 119%

Atlantic Tele-Network Inc. ATNI -2% 89% 19% 504%
 

Aqua America Inc. WTR 3% 53% 103% 135%

OGE Energy Corp. OGE 11% 65% 161% 319%

Questar Corp. STR -1% 32% 113% 267%

 

S&P Composite 1500 Index 5% 78% 104% 115%

 

Total returns assume the reinvestment of dividends.

 

Source: FactSet

 

This hasn't been such a good year for the group, with only 12 of 30 beating the 5% total return for the S&P 1500. But over longer periods, the story changes.

 

Over three years, 17 have beaten the index, and 14 have more than doubled.

 

For five years, 21 have beaten the S&P 1500, with 10 more than doubling the performance of the index.

 

Going out 10 years, all but one of the 24 companies (six haven't been publicly traded that long) have beaten the index. The average return is 573%, compared with 115% for the S&P 1500.

 

So being highly profitable provides protection against the type of decline that took so much out of the index during 2008 at the height of the credit crisis.
 

Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

 

https://finance.yahoo.com/news/24-most-profitable-companies-return-100058741.html

Three categories of businesses based on the cost of business growth: Great, Good and Gruesome

Buffett uses a simple checklist to determine the attractiveness of businesses as investments.  To meet his tests, companies must possess:

1.  a sensible price tag
2.  durable competitive advantages
3.  business he can understand
4:  managers who have integrity and who are passionately involved in their business creations.

Even though he is not involved in the day-to-day operations, Buffett pays close attention to how much cash each business generates.  He determines how much is needed to maintain a rate of appropriate growth and how much can be invested elsewhere to build intrinsic value in the Berkshire enterprise.

In his 2007 shareholder letter, Buffett offered a capsule view of how he assess companies based on their capital allocation profiles.  He sorts businesses into three categories based on the cost of business growth:  great, good, and gruesome.  This sorting allows him to see sizzle where others cannot.

Buffett devotes his precious time to reading and thinking, looking for gaps in values that others miss.

In 1999, after 34 years in business, Berkshire had a market capitalization that positioned it as the 74th largest American company.  Yet it had no Wall Street research coverage.  In 1999, Alice Schroeder, a Paine Webber research analyst, wrote the first Wall Street research report on Berkshire. 

Buffett continues to rely on his managers to run their day-to-day business operations.  he continues to devote precious time to reading and thinking.  Like a miner panning for gold, he sifts data from newspapers, annual reports, and other publications, looking for gaps in values that others miss. 

Analysing the substance and character of a business is the holy grail of investing. Guessing a price that someone else is willing to pay, is not.

By 1969, the stock market had reached new highs, and the Buffett Partnership continued to beat its returns.  As the market continued to climb even higher, Buffett announced that he would close his partnerships.  He told the partners that the speculation-driven stock market didn't make sense; he wanted no part of the folly.

Buffett sold everything in the portfolio except for shares in Diversified Retailing, Blue Chip Stamps, and Berkshire Hathaway, which now included insurance and banking businesses as well as equity investments.  Avoiding the speculative market, Buffett continued to hunt for attractive underated businesses.  In 1971, he bought a controlling interest in See's Candies.

By early January 1973, the Dow had climbed to an all time high of 1,051 points.  But only $17 million of Berkshire's $101 million insurance portfolio was invested in stocks; the rest was in bonds.  Not long after this high, the market swooned.  The it racheted down further.  By October 1974, it hit a low of 580 points.  Investors panicked but Buffett rejoiced.  He was in his elements once again.

Over the following years, Buffett bagged big game at  bargain prices, adding Wesco Financial and buying large blocks of stocks in The Washington Post and Geico.  In 1977, Buffett bought The Buffalo News. 

Buffett's belief that analysing the substance and character of a business was the holy grail of investing.  Guessing a price that someone else was willing to pay - irrespective of fundamentals - was not.

Cinderella at the Ball. Warning investors about the "sedation of effortless money".

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs.  Nothing sedates rationality like large dose of effortless money.  After a heady experience of that kind, normally sensible people drift into behaviour akin to that of Cinderella at the ball.  They know that overstaying the festivities - that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future - will eventually bring on pumpkins and mice.  But they nevertheless hate to miss a single minute of what is one helluva party.  Therefore, the giddy participants all plan to leave just seconds before mid-night.  There's a problem, though:  They are dancing in a room in which the clocks have no hands. 


Warren Buffett's Cinderella parable in his 2000 shareholder letter.

In a financial crisis, when banks cannot lend, cash is particularly valuable.

Buffett is a balance sheet guy.  That's where the cash is reported.  Cash is the fuel that drives economic value.

Most CEOs, however, focus on growth in corporate profits more than on cash and balance sheet growth.  The source of the problem is:  some of the reported expenses in these income statements are cash, and some are determined by accounting rules.  As a result, earnings include both cash and noncash (i.e., "accounting") numbers.  Buffett cares most about the cash part.

Cash is real.  Noncash earnings are subject to accounting interpretations.  They can be adjusted to inflate earnings and boost the stock price.  But it is harder to fiddle with the cash numbers.

Buffett's long-term cash obsession creates unique opportunities that others miss.  Buffett keeps a lot of cash on hand in order to be ready for unique crisis-born opportunities.  "Do we panic when the price of filet mignon drops?  No, we rejoice.  Who wouldn't want to buy the highest-quality steaks at chopped meat prices?"

At the end of June 2008, cash represented just over 11 percent of Buffett's balance sheet.  He used some of it to provide high-cost financing for then top-credit-rated companies Goldman Sachs and GE, both desperately in need of cash.  He announced his biggest acquisition to date - buying the Burlington Northern Santa Fe Railway for $34 billion.  At $100 a share, he paid a reasonable, but not a cheap, price.

Why Buffett decides not to pay out dividends in 45 years in Berkshire Hathaway?

He has been able to reinvest Berkshire's profits at rates considerably higher than Berkshire's investors could have earned y reinvesting them in the market. 

When the company can no longer meet the test of reinvesting $1.00 of EPS to create $1 of additional value, then, says Buffett, Berkshire will pay dividends, and let his owner-partners reinvest the cash.

Ask yourself this ONE question, every time a stock price goes up or down.

Every time a stock goes up or down, you should ask yourself:

Is this price movement based on changing fundamental or changing sentiment?

Sometimes the answer is not so obvious. 

In such a situation, here is a good guiding principle.

It is better to be approximately right than to be exactly wrong.

Essentials of Value Investing

The Intelligent Investor by Benjamin Graham and Greenwald’s Book: Value Investing from Graham to Buffett and Beyond.

Class Case Studies

This is a class in a specific kind of investing. There are two basic approaches. There are short-term  investors (preferably not investing taxable money). Many technical investors who do not care about the underlying quality of the companies invest solely on price information. Although some value investors build a time element into their investments. There are investors who look at short-term earnings. Analysts spend their time on earnings’ forecasting. If you think IBM is going to do $1.44  vs. the analyst estimates of $1.40, then you buy IBM, because analysts are behind the real growth in earnings. Your estimate is correct.

Another group, who has given up altogether, they believe the markets are efficient; they index.  Unless the distribution is very skewed, then only 50% of the investors can outperform the market. This is a market for long-term investors with a particular orientation (value investors). You look at a security and it  will represent a claim on earnings and assets. What is that claim worth? If you think that a company is worth $22 to $24 per share, then you look to buy with a margin of  safety. When the margin of safety is sufficiently large, you will buy. You will look for bargains.

Value Investors constitute only 7% of the investor universe. There is substantial statistical evidence that value investing works: higher returns with lower risks than the market.


Value Investing (“VI”) rests on three key characteristics of financial markets:

1. Prices are subject to significant and capricious movements that can temporarily cause price to diverge from intrinsic value. Mr. Market is to offer you various prices, not to guide you.  Emotionalism and short-term thinking rule market prices in the short-run.

2. Financial assets do have underlying or fundamental economic values that are relatively stable and can be measured by a diligent and disciplined investor. Price and value often diverge.

3. A strategy of buying when prices are 33% to 50% below the calculated intrinsic value will produce superior returns in the long-run. The size of the gap between price and value is the "margin of safety

We put someone (into business with a value formula that has averaged 20% plus returns over the past four years. He will be on the show, Imposter!

The preponderance of evidence is overwhelming for value investing as a good approach.
1. Statistical evidence
2. Performance evidence of big value funds (Oakmark, Third Avenue, Fairholme, Tweedy Browne)
3. Relatively episodic evidence that a disproportionately large amount or percentage of successful investors follow the value approach.

All human beings have certain predispositions that hurt themselves and prevent them from following 
the value approach.

Essentials of Value Investing

Long-term - Fundamental (Look at Underlying Businesses)

Specific Premises

(1) Mr. Market is a strange guy - prices diverge regularly from fundamental values

(2) You can buy under priced Stocks - fundamental values are often measurable

(3) Fundamental value determines future price - Buying under priced stocks plus patience implies superior returns.

Patience helps create time arbitrage between short term focus and long-term values.

http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Why Value Investing works. Buying cheaply works.

WHY VALUE INVESTING WORKS

Markets are not Efficient
All you should worry about since you aren’t going to be able to outguess the market is minimizing transaction costs, and allocating assets that creates an appropriate risk profile. What I think you ought to know about that is two things.

• The first is that there is overwhelming statistical evidence that markets are not efficient. In all countries and all periods of time since the early 20th century, that there are variables that can be reliably used to outperform the market and that clearly contradicts the premise that nobody can outperform the market. 
• There is a sense in which absolutely and fundamentally markets are efficient and it is this—that when we buy as night follows the day someone else is selling that stock thinking it is going down--and one of you is always wrong. (Don’t play the patsy!)

Why Are You on the Right Side of the Trade?
Another way of saying that is not everybody can outperform the market. The famous humorist called Garrison Keiller talks about a fictional town called Lake Woebegone. In Lake Woebegone all the women are beautiful, all the men are tall and all the children are above average. In this game all the children are average on average which means half of them underperforms the market. So when you start to think about investing, you must be able to answer the question:

• Why are you able to beon the right side of the particular trade? 
• Why are you the one who is right, and the person who is trading with you is wrong? That is the most fundamental aspect of Investing. 
• Where and what is your investing edge? 
• What puts you on the right side of the trade?

Buying Cheaply Works
When we talk about value investing there is a lot of evidence that value investors have been on the
right side of the trade. 

• The statistical studies that run against or contradict market efficiency almost all of them show that cheap portfolios—low market-to-book, low price-to-book—outperform the markets by significant amounts in all periods in all countries—that is a statistical, historical basis for believing that this is one of the approaches where people are predominantly on the right side of the trade.  And, of course, someone else has to be on the wrong side of the trade.
• Those studies were first done in the early 1930s; they were done again in the early 1950s. And the ones done in the 1990s got all the attention because the academics caught on. There is statistical evidence that the value approaches—buy cheap securities—have historically outperformed the market.  Buying Cheap works.

http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf