Insights on Value Investing

The investing Master Class /Insights on Value Investing?

“Whether we are talking about Socks or Stocks, I like buying quality products when they are on sale”

– Warren Buffet

This is Value Investing in a nutshell. This approach is aimed at taking advantage of the irrational behavior of the people in the market.

Suppose you are interested in buying a house to earn rental income out of it. How much price would you be willing to pay?

First of all, let’s see what benefit you will get out of this –

For example, you want to hold it for five years.

So, in this case, you would not pay more than the total rent you would earn in these 5 years + expected selling price after five years. Similarly, paying the amount equal to the sum of rental income and sale realization would not make sense because, what would you gain if your total revenue is equal to total expense. So, to arrive a value deal, your purchase price should undoubtedly be less than your total expected income.

As an investment paradigm, value investing refers to the purchase of shares for less than their worth. When we say “value investing”, both the words “value” and “investing” are significant. First, the investors are required to do an accurate valuation and secondly, they should believe in “investing” and not just trading or speculating.

While value investing, you do not focus on the market, i.e., when the market price is high you sell and when it is low, you buy. You must rather focus on the value of the stock. If the value is lesser then the market price, you sell, while if the value is higher than the market price, you buy it. For value investors, a stock is fractional ownership of a company and the value of the stock is the value of the underlying business.

Let us understand the strategies of some well-known value investors –

Benjamin Graham

Benjamin Graham is referred to as the “father of value investing.”  He started valuing the stocks at the time of great depression- 1930’s when shares were trading very cheap.

His methods to value the stocks were based on quantitative factors, he just focused on profits, returns, etc. of the company and not on factors that he can’t be sure of like management capability, corporate governance, etc. Some vital contribution of Benjamin Graham in the field of value investing are –

• The margin of safety – Graham used a very conservative approach while doing the valuation of the shares. He stressed on the margin of safety for the protection of capital. So, if according to your valuation, the fair value of a share should be Rs 100; you should not buy it for more than Rs 80. If investors seek higher safety of capital, they should go on to increase the margin of safety. The reason behind this is that the future is uncertain and our estimates may be wrong.
• Mr. Market – Graham personifies Mr. stock market to be very moody. If he (stock market) is in a very optimistic mood, he will offer you very high prices and if he is in a depressed mood, he will offer low prices. The investors have the option to buy from him, or sell him or even ignore him. A rational person should fluctuate as per his mood and focus on stock valuation and as Mr. Market is moody and emotional, patience is an important virtue when dealing with Mr. Market.

Peter Lynch

Peter Lynch is one of the best mutual fund managers of the world, who is also considered as one of the most influential personalities in the development of value investing. Some of his greatest investment teachings are-

• Invest in something you know or understand – Lynch said that buying a share is not like buying a lottery ticket. There is a company behind every stock. His approach is based on research before buying a company and buying only those companies that you understand.
• Flexibility – the reason behind lynch’s unusual performance was his rare degree of openness and flexible approach. He believed in not getting too attached to the investments. If stocks are not giving promising returns then they should not be just held because you like the company.
• Find unexciting companies – According to Peter Lynch, you should “Never buy the hottest stock in the hottest industry”. These companies tend to be overvalued. He focused on buying the stocks of companies ignored by the market, stocks boring companies of some boring sector and be patient with your holdings.
  
  Peter Lynch would Prefer stocks with low debt and steady growth rate., you will get a ready list of such stocks for your convenience.

Warren Buffet

Warren Edward Buffett is an American business tycoon, investor, speaker and philanthropist. He is the current chairman of Berkshire Hathaway and has a net worth of US$83.1 billion, making him the third-wealthiest person in the world. He is considered as one the most successful investor in the world. His Investment Strategy says-

1. Buy a business, not a stock

As per Buffet, investment must be viewed from long term perspective of a businessman. The following things you need to be considered while making your investment decision.

• Invest in what you understand – Buffet believes that investing based on other’s recommendation leads to failure. So, as an investor, your selection should be based on your research. An investor should always go for a company which is familiar to him, as it will more comfortable for him to keep track of industry trends and business news.
• Hold a stock for a long term – Warren Buffet famously quoted “our favorite holding period is forever.” Buffet invest philosophy emphasizes on long term investment. He had held some of his stocks for several decades. He says that quality business offers good returns and create value over some time and investors who own it can only create wealth. Additionally, Continuous buying and selling the stocks destroy the potential gain in form brokerage, tax or other charges.

2. Know the difference between Price and Value

Buffetology (teachings of Warren Buffet)  also outlines the importance of intrinsic value. According to him, share prices fluctuate more than its fundamentals. It means in the short run; stock prices move in relation to the emotion of the investor. When the market is surrounded by extreme optimism and shares prices are moving up, many investors enter the market without giving due consideration to its real value.

He has highlighted different methods for valuation like Discounted cash flow, Earning yield, etc.

3. Always go for a trustworthy management

Many times Warren buffet quoted about the importance of investing in companies run by credible and competent management.

For assessing the management quality,Buffet uses the following criteria

• Rationality of the management while taking the key business decision like financing, capital allocation or dividend decision, etc.
• Transparency of the management during communication with the shareholders.

4. Manage a portfolio of business, not stocks

Warrant buffet does not believe in broad diversification. He said “Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing”. It means broad diversification makes sense for those who don’t know anything, and index funds are the best solution to them. His philosophy is based on the idea that the market rarely offers good companies at a reasonable price. So, concentrating your portfolio in a smaller number of holdings which you find attractive is better than investing in a large number of stocks which you don’t know.

Investing is simple with proper guidance & handholding. No prior Accounting or Financial Knowledge is required in it. Investing is more about qualitative analysis rather than financial number crunching. Please remember – Best Accountants are not the best investors. Thus, investing is more of a psychological activity, that anyone can master.

Charlie Munger

Charlie Munger is an American Stock investor, the owner and Vice-Chairman of the company called Berkshire Hathaway. Charlie Munger has been one of the most successful investors and a well-known philanthropist. Charlie Munger and Warren Buffet are business partners and are known for their simple and logical philosophies that revolve around business, investment and life in general.

If you can get really good at destroying your own wrong ideas, that is a great gift.

– Charlie Munger

Here, are a few philosophies for stock investment that are used by Charlie Munger:

1. Lose money, but not reputation: You can afford to lose a lot of money but you cannot let your reputation get affected at any point of time.As per Charlie Munger, the businesses are built and run on trust and you must not let anything affect your brand name even to the smallest extent.
2. Review mistakes to gain experience:Every new experience comes with learning in itself. Charlie Munger believes in constantly reviewing his own mistakes made in the past to refresh his memory to avoid repeating the same mistakes again.
3. Be simple in your investing approach: You must try to invest in simple businesses that make sense to you rather than opting for complicated ones. Simple businesses are the safest bet as they are easy to be analysed and understood.