In this post, I will write an introduction to value investing and what the value investing concept means to me.
First and foremost: a stock is a share in a company. It represents real assets and is not just numbers on a screen. Value Investing can be briefly described as a process in which the investor makes a difference in the price the stock sells for and its intrinsic value.
A company’s intrinsic value can be defined as the cash flow from the date of the investment the company will obtain, discounted back to the present (the real business value).
Since this definition is about the future, it’s necessarily somewhat arbitrary. The intrinsic value is not something that can be precisely defined, so what you and I have to work with is the range of the intrinsic business value.
A value investor strives to find stocks that sell way below the range of the intrinsic value. The market sets the prices of publicly listed stocks, and the market is not always right. Value investors actively seek stocks of companies that they believe the market has undervalued.
Using careful analysis and looking toward a longer investment horizon (longer than next quarter), I believe we can identify stocks that sell below their intrinsic value. The lower the price of per share, the higher the expected return when the market corrects the price of the business.
Of course, there is more to it than looking for stocks that sell at an all-time low. The underlying business must be good, the future of the industry must be sustainable, the management must be competent, and the balance sheets and financial statements must be solid.
The margin of safety concept, presented by the father of value investing Benjamin Graham, is another factor to always consider before buying a stock. The margin of safety means you want the price of the stock to be substantially cheaper than the underlying intrinsic value of the business.
This means I’m not willing to pay, say, 94% of the estimated value of a stock. However, if the shares are trading at only 50% of the estimated intrinsic value, it’s definitely worth taking a look at the company.
For example, let’s say you are looking to buy shares of Lannet Company, Inc. that are selling for 18.32 per share and you are valuing the intrinsic value of between 20 and 24 per share. In this scenario, I would not buy the share since it does not give me enough of a margin of safety.
It’s too close to the arbitrary value we think the asset has. However, if I would value the company at 30 to 34 per share, it would be a more valid investment since the margin of safety would give me more of a cushion to fall back on.
Value investors do not obsess about the share prices throughout the day because they are more concerned about the long-term outlook.
Value investors do not speculate on quarterly reports to come in better or worse than people expect, or that a company has some positive news in the pipeline. The horizon is much longer than that. It is counted in years, not in days or weeks.
Do not listen to all the experts and analysts who speak out in the media. Do your own research!
Remember that the rise or fall in prices of a stock is not necessarily a reflection of the company’s underlying business. Quick profits and speculation is the opposite of investing.
Last year I bought stocks from four companies throughout the year and sold two, and it was an exceptionally active year.
Value investing is about being rational, logical, thorough, and perhaps most importantly, patient. These are some of the values I try to follow in my investing. It’s not as easy it sounds but like everything else, practice makes perfect.
As you can probably see, these concepts and thoughts on investing are highly influenced by Ben Graham. If you would like to learn more about value investing, I highly recommend you read his books, The Intelligent Investor, The Interpretation of Financial Statements, and Security Analysis.