Value Investing

As simple as it sounds, value investing refers to the investment in particular company when it’s ‘intrinsic’ value is above its current market price. As we all know, market price doesn’t reflect the true value of the company, instead it is an end product of numerous factors. Some of them includes greed/fear in the market, supply/demand of the stock and most importantly, the future expectation in that company. When investors are optimistic about the future prospect of a company, they will keep loading up the shares in hope that the market will reward them handsomely when the company delivers outstanding results. This also explains why share price always plunges after a set of bad results but are somehow cushioned when the management gives a promising outlook of the following quarter. It’s all about expectation!

If you ever come across this book called “The Intelligent Investor“, spare a few moment to flip through the content page/synopsis. It is written by the Ben Graham, the very mentor of Warren Buffett! The content can be quite lengthy but for the benefit of those who are busy, i will attempt to summarise the 2 most important chapters.

Chapter 8: The trend is your friend!

The analogy – if the markets were to pass a few lemons to you, you shall make lemonades with them and if they suddenly decides to take back the lemons and start giving you apples, well then, quench your thirst with apple juices. This means that the market is always your friend and it will reward those who befriended him. On the flip side, it will show no mercy for those who tries to defy it.

Chapter 20: The concept of margin of safety!

Personally, i feel that this is one of THE MOST important concept in value investing. It may seem deceivingly simple but i wonder how many ppl actually calculate this figure before jumping straight into an investment.

An example speaks a thousand words: Assuming that you have calculated the intrinsic value of company ABC as $1/share. When you actually managed to get a piece of the company at $0.80/share, you have gotten yourself a margin of safety of 20%!! This means that you are not overpaying for the share of ABC and in fact, you are 20% safer than those people who bought it as the true value of $1. Next, imagine that the market is fairly efficient and you can only buy the stock at $0.90. Immediately, your margin of safety would have fallen to 10% from 20%. In summary, you can only accumulate stocks with the highest margin of safety when there are adverse bad news on the company, that is when the expectation of the company turns 180 degrees. However, in actual practice, it is always safer to let the share price stabilizes after any major earth-shaking news before loading them up as the institutional investors (those who got more bullets than you do) might have to sell the stock due to certain mandate they abide to.

FYI – here are some guidelines for those who aspired to be a value investor:

  1. Look out for business that are easy to understand. This will help simply the investment process.
  2. Invest in companies that have a monopoly/oligopoly in their industries. Market leaders are price setters in their own market and are able to fend off competitors given their size.
  3. Pay special attention to companies that have a profitable history, replicable and sustainable business model that have an edge over the rest.
  4. Add companies that have a sustainable ROE (return of equity) into your portfolio. When i said sustainable, i meant > 20% ROE for a period of at least 10 yrs.
  5. Buy into companies (non reits) that have a good dividend payout record, eg.) 4%-5%/yr for a period of at least 10 yrs. This will cushion your portfolio during periods of high volatility…like now

Hope this helps! Stay tune for ways to calculate the intrinsic value of listed companies in my next post!


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