Another email from KCLau and it is about investment. I’ll share with you.
What is ‘Value Investing’?
‘Value Investing’ is just another term for taking advantage of the market at the right moment. Just like bargain hunters, you hunt for stocks that are grossly undervalued based on their ‘intrinsic worth’. In theory, a company’s stock value should be the same as its market price. However, often they are not the same in the short term.
Sometimes price > value (overvalued), or price < value (under-valued). By analysing its fundamentals and projecting the future profits the business is going to generate in its lifetime, you can estimate whether a company is underestimated in the market or not. If so, you get to buy its stocks at a bargain in the hopes that the market will turn it in their favour in the long run. These value stocks are being sold below their intrinsic value and have huge potential to grow in the future when the price is adjusted accordingly.
Understanding Value Investing is vital before proceeding into any investment.
If you look at the chart above, the red line indicates the company’s potential or intrinsic value. In the beginning, due to its low value, the market misinterpreted the situation and quickly undervalued its stock. Value investors wait for this golden opportunity to buy the shares at a discounted price. They know the company has future growth potential. They then sell their stock when the market price is overvalued, earning them a nice big profit.
Why Value Investing Works
It forces investors to do the unnatural: buy low and sell high. Often, Individual investors underperform because they buy more when confidence is high, and market nears its peak. On the other end, when all news is doom and gloom, people stay at the sideline and are fearful to put money down. This is what separates them from value investors.
Value investors don’t chase recent performance. They are the contrarian and tend to buy more when others are fearful. This is the time when stocks are undervalued (red area in the graph). It is when you can buy great assets at a huge bargain. However, how do you know when the stock is undervalued and its intrinsic value?
This is where the margin of safety comes in. It means that you are purchasing at large enough discounts to permit some room for error. Let’s say that you feel a stock is worth $20 but is currently sold at $17.50. Buying at this price will ensure a margin of safety. Just in case your analysis is incorrect, you have a margin or buffer to allow that mistake.
Now look at this simple logic: say every month you need to buy a 2kg soft pack, Milo. Price ranges RM32-42 would you buy more at RM32? Would you be happy if your neighbour sells it to you at RM20 for whatever reason? Shoppers will rejoice when Giant or Tesco are selling it at a deep discount, say RM18! They will call their parents, their daughter-in-law, their neighbours and their daughter in Sarawak to ask if the relatives want to stock up more Milo?!
Surprisingly, when established businesses are selling at a deep discount, usually during the great recession, everybody shows sour face and ask their friends to stay away from the stock market. If you can spend more time shopping for businesses than you do shopping for clothes, you will be a much better investor.
What are the advantages of value investing?
Unlike active trading that uses technical analysis indicator – value investing can be done on a much bigger scale. Day traders use various indicators from a company’s past to predict its future. They follow different trends like money flow, volatility, momentum, etc. to produce a mathematical chart.
However, a simple fact is inevitable – WE DON’T KNOW THE FUTURE unless you create it. If I am not the majority owner of a business and I don’t run the show, it is tough for me to predict its share price.
While on the other hand, fundamentalist investors rely upon past annual and economic reports. It is the same method whether you are investing RM10k, or RM100k, RM1 million or RM100 million via value investing. You are only buying great businesses that are at a bargain sale. As long as the company keeps producing profits, you as an investor make money by holding the shares.
This investing is quite passive for investors in a way. You might have to hang on to the same stocks for decades, provided that the earnings keep growing. Most people ask about when do you sell a stock? You can keep the good company assets as long as the company is still making significant profits, or you may sell when you find other value-buy, and you are short of capital to do that. Then you can consider selling your fully valued or overvalued stocks to deploy your capital more efficiently.
Who Else Are Doing Value Investing?
Benjamin Graham was the mentor to the one and only Warren Buffet and was known as the father of value investing. His more than 60-year-old strategy is still used as the bible of investment! Mainly, Graham usually puts his faith in financially sound firms with net current assets greater than its long-term debt.
He also preferred to invest in companies with a well-diversified portfolio to evenly spread out risks. However, any business would do as long as you remember his golden rule – ‘margin of safety’.
On the other hand, take John Templeton for instance, who single-handedly created some of the world’s most successful international investment funds. His mantra about value investing is to search the world for a bargain stock but one with an excellent future outlook.
In contrast, the legendary Peter Lynch, one of the most famous investors worldwide, built his fortune on ‘tenbaggers’. A ten-bagger is a company that appreciates its stock value ten-fold in the long run! He had an excellent ability to pick undervalued stocks that are just diamonds in the rough.
For more article just visit KCLau website