Value Investing

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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jjk2
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Value Investing

Post by jjk2 »

hello i am new to this forum.

i used to daytrade currencies but im just taking a rest from it, there is too much noise to go through with it everyday and i've always been interested in investing....i think its more passive relatively compared to trading.

i am trying to learn how to invest with value philosophy

how does everyone do it? i would start off with a company i can identify right away with a economic moat against competitors.

then look at the qualitative traits of the company, management, and so on (leaving the math to the last )

then do discount the financial statements and so on.

but i have never found any "margin of safety" ! am i doing something wrong.

Thank you for reading.
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Post by glennchan »

You might try getting a copy of "The Intelligent Investor". You can likely borrow it at the library.
how does everyone do it?
I think it works because not everybody is doing it. If everybody was doing it, markets would be a lot less volatile and you wouldn't get an edge from value investing.

One of the tricks is to act rationally and not on your emotions. You also have to have a little bit of the right kind of smarts. For example, if you look at the now-defunct hedge fund Long Term Capital Management... it was run by extremely educated and intelligent people (including two Nobel Memorial Prize economists on its payroll)... but they did not have the right kind of smarts. Their fund blew up and lost a lot of money.
i would start off with a company i can identify right away with a economic moat against competitors.
You might be missing the larger picture. At the core of it, you are trying to buy businesses for less than they are worth.

Though definitely a part of value investing has to do with managing risk. If there is a lot of uncertainty about the underlying company, then your risk is higher.
If a company has some sort of competitive advantage/economic moat, then there's less uncertainty about that company. You can guess it will do fairly well in the long run and has less of a chance going bankrupt or doing very badly. e.g. Coke is less likely to go out of business than its competitors, since the Coke brand is so valuable. Whereas a search engine company like Altavista or Yahoo might quickly lose a lot of its business, Coke won't lose a lot of its business in a short timespan (those search engine companies don't have an economic moat).
But simply having an economic moat doesn't make a company a good buy. It might be overpriced at the current time.


This is as I understand it anyways. The core of it is buying companies for less than they are worth.
Contrast this with other investing styles/strategies like technical analysis, where you don't evaluate what the underlying business is worth.
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augustabound
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Re: Value Investing

Post by augustabound »

jjk2 wrote: i would start off with a company i can identify right away with a economic moat against competitors.

then look at the qualitative traits of the company, management, and so on (leaving the math to the last )

then do discount the financial statements and so on.

but i have never found any "margin of safety" ! am i doing something wrong.
Maybe a couple of questions first.
How are you defining a moat? Most people agree that Coke has a huge moat that's been sustained for a hundred years, but some think that Starbucks has a moat also. If you've read some threads here, there are good arguments for both sides of that. That being said, if there are good points on both sides then there probably isn't a moat when a lot of people think there is.

What method are you using when you say,"discount the financial statements"? Discounted cash flow? Maybe your assumptions are too conservative if you're not seeing a MOS. Discount rates vary depending on the person, some use 8% and others may use 15%. Warren Buffett has said that he uses the value on a 30 year US bond(today it's near 4.3% I believe). He also uses owner earnings and not free cash flow when discounting future cash. What margin of safety are you looking for? 25% 50%?

I found arnyks thread over at CBForums interesting on valuations.
http://forums.canadianbusiness.com/thre ... 7&tstart=0
He made some really good points on choosing which company to invest in depending on your margin of safety.
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Post by glennchan »

I think when it comes to value investing, I would disagree with arnyk's comments on financial companies.

One problem with them is that it is uncertain what risks lie underneath and what the real value of the company is. A great example would be CIBC and the subprime mess. It looks like they've been earning good profits for several years, but then things blow up and you really discover that they've lost money over that period (or haven't been doing well).

Normally you can look at a company's balance sheet over the past few years and it will be a good predictor of future profits. e.g. if a company has made consistent profits, it's very likely they'll make a similar profit in the future. But you can't say that by looking at the balance sheets of a banking or insurance company.
The bank will exist in 10 years. lol
In my opinion, this is an extremely bad assumption. Banks can do stupid things and lose a lot of money.
e.g. Savings and Loans crisis, Barings bank, SocGen, subprime, etc.

2- Banks would be worth investing in if:
A- The underlying business is underpriced.
B- You can be confident that the management is good and won't do stupid things. Because when they do stupid things, it looks like they're very profitable but they really aren't. (This is really the same thing as A.)
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Do we digress?

Post by Sensei »

Hi,

I'm also a newbie to this forum.

I wonder if some of those answers really helped jjk? Like Augustabound, I'd have some questions, but in particular relating to current level of investment knowledge. It seems like a huge leap from day trading currencies to value investing, almost opposite ends of the scale.

Value investing is a legimate form of investing, but may not be suitable for everyone, but the really successful investors have access to much more information. For example, I'm sure if Buffet phones a company, he'll get the info he wants. We retail investors have to content ourselves to scouring through the company reports to actually find a company that is really cheap. Also, I don't think a 50% margin of safety, the one that Benjamin Graham suggested, is really possible these days. Buffet also used different benchmarks depending on the industry when he was calculating present value of future earnings.

We might be better off listening to Charlie Munger who finally convinced Buffet that it is also a good idea to buy any good company even if there is a slight premium involved (and never sell it). Coke (KO) would be a good example. I'm sure Buffet never got it for 50% off.

I've also read through two or three books on Buffet, for example by his chief chronicler Hagstrom, and I found that no two deals have ever been really the same. For example, no one really knows why he bought Washington Post other than with the wisdom of hindsight. It wasn't very clear at the time. Now he's talking Ambac (I think).

Anyway, my suggestion would be to read. The Intelligent Investor is no doubt a mine of information, but I'd get the edition annotated by Jason Zweig. If you want something that is a bit easier to understand and easier to implement, Magic Formula investing distills two Graham principles by finding companies with high ROC + high earnings yields and the website offers a list of the top companies in various cap ranges that fit the bill. It is a place to start anyway. Rule #1 by Phil Town is an easy read. The book on Dhandro investing also makes some good points.

As a disclaimer, I'm not really interested in value investing per se. I'm trending toward dividend growth investing. Also, stocks are a relatively new investment for me.

jjk asks how do you do it? My guess is, with the current investment climate, a lot of people, even seasoned investors, are asking the same question.

Cheers
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Re: Do we digress?

Post by George$ »

Sensei wrote: .... Value investing is a legimate form of investing, but may not be suitable for everyone, but the really successful investors have access to much more information. For example, I'm sure if Buffet phones a company, he'll get the info he wants. We retail investors have to content ourselves to scouring through the company reports to actually find a company that is really cheap. ....
True. Buffet has many advantages but also some disadvantages - he can only hunt elephants whereas we can go after small game and there are far more of them.

If I was young (I'm not) and wanted to try follow Buffett's footsteps - I would go back and study what he did in the beginning (when he was young) - not what he is doing today. Back then, like us, he could not pick up the phone and get information or wait for opportunities to call him.
“The search for truth is more precious than its possession.” Albert Einstein
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Post by Sensei »

George wrote:
If I was young (I'm not) and wanted to try follow Buffett's footsteps - I would go back and study what he did in the beginning (when he was young) - not what he is doing today. Back then, like us, he could not pick up the phone and get information or wait for opportunities to call him.

George, I would and have gone back and studied what Buffet did in his early days. However, in the case of Buffet, his father was a local stockbroker and Warren started reading his father's books about the market at age 8 and marking the board at the brokerage house where his father worked at age 11, so we'd have to go a long ways back! He was also a gifted mathemetican (and still is).

Anyway, the point is we don't know anything that really counts about jjk, like his age, investment goals, or current investment knowledge, so his question is near impossible to answer.

Best I can say is to start reading a lot including what Buffet did when he was young and what he is doing now. Check out other methodologies as well such as index investing, mutual fund investing, dividend growth investing etc. Along the way, focus on a strategy or two and stick with it or them.

Cheers
Last edited by Sensei on 16 Mar 2008 08:00, edited 1 time in total.
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Re: Do we digress?

Post by glennchan »

Sensei wrote:but the really successful investors have access to much more information.
It doesn't seem so. When Buffet started, he didn't do much more than read the annual reports (and sometimes visit the businesses or try their products). Walter J Schloss pretty much only reads annual reports.
The article "THE SUPERINVESTORS OF GRAHAM-AND-DODDSVILLE" goes through many of the points people raise.
http://www.tilsonfunds.com/superinvestors.html

Since that article, there has been things like the 1987 market crash and the Internet bubble.
Also, I don't think a 50% margin of safety, the one that Benjamin Graham suggested, is really possible these days.
That's why many value investors hold cash when there are no good opportunities in stocks (or other securities).
We might be better off listening to Charlie Munger who finally convinced Buffet that it is also a good idea to buy any good company even if there is a slight premium involved (and never sell it). Coke (KO) would be a good example. I'm sure Buffet never got it for 50% off.
By definition, value investing is about purchasing companies for less than their intrinsic value. So that idea doesn't really make any sense. (?) Unless the slight premium refers to book value, which is not the same as intrinsic value.
For example, no one really knows why he bought Washington Post other than with the wisdom of hindsight.
At the core of it, he presumably thought that the company was selling for less than its intrinsic value. As to why that he felt it was undervalued, Roger Lowenstein's biography on Buffet has some insight on that.
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Re: Do we digress?

Post by augustabound »

glennchan wrote:
For example, no one really knows why he bought Washington Post other than with the wisdom of hindsight.
At the core of it, he presumably thought that the company was selling for less than its intrinsic value. As to why that he felt it was undervalued, Roger Lowenstein's biography on Buffet has some insight on that.
Agreed. In "The Warren Buffett Way" by Robert Hagstrom, he states the market value of WPO when Buffett bought was $80 million. His valuation estimates for WPO was $150 million using his method of discounted cash flows,(he prefers owner earnings to free cash flow), but the true value in his mind was between $400-500 million because of some intangibles that only he saw in the company.
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Post by Sensei »

Glennchan, you are right about reading the financial reports, but visiting the businesses...? Thanks for the URL, however. I'll have a look.

Augustabound, I'm fine and thanks for asking and welcoming us newbies to FWF.

Obviously, anyone who can replicate what Buffet does would be a genius and very rich, so I'm not saying don't be a Buffet! What I am saying is that his methodology would be difficult to replicate (I'll read Glen's URL though) but for now let's just agree to disagree that everyone has access to the same information.

In Hagstrom's books, Munger's name comes up quite frequently. Most notably he convinced Buffet to buy See's Candy at three times book value and that it was a good deal. And, none of the Washington Post, Capital Cities / ABC, or Coke purchases strictly passed the Benjamin Graham test and the thinking behind each was different in very basic ways. That's from The Essential Buffet, BTW. Obviously, Buffet saw value where others didn't (I don't need to be told that) but it is also fair to say that many were mystified by the logic he used at the time.

Anyway, dotting our i's and crossing our t's vis-a-vis buffetology is interesting, but a little irrelevant since jjk hasn't responded.


Cheers
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Post by augustabound »

his methodology would be difficult to replicate
That's what makes him Buffett. Nobody can.

Munger's name comes up quite frequently.
They make a great team and in most respects Charlie doesn't get his due respects from most people.

Obviously, Buffet saw value where others didn't (I don't need to be told that) but it is also fair to say that many were mystified by the logic he used at the time.

I rarely question Buffett, but I also understand that he invests for different reasons that I do.......I haven't made my billions yet. :wink:
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Post by glennchan »

visiting the businesses...?
I recall reading that Buffett went to a movie theater to see how people responded to Disney movies.

2- I think where Buffet and Graham differ is that Graham is highly defensive/risk-adverse and that Graham is not a fan of subjective evaluation of businesses. Subjective evaluation can be skewed by emotion/irrationality, so it can be dangerous. Perhaps the reason why value investing works is because others are using subjective evaluations and making mistakes in them.

Part of it might also be because Graham was burned by investing on margin.

3- I think Buffet indicates that he buys businesses for very simple reasons. It's about getting the big picture right, not the little details. The little details (e.g. growth rate of the GDP) just isn't very significant.

I think the reason why he invested in the Washington Post is because it was the only media outlet in its city (ignoring the TV stations for now). When there is only one newspaper in town, it becomes highly profitable because it can increase its ad rates since there isn't competition. And any competitors that spring up will likely go bankrupt since people tend to subscribe to the biggest newspaper (size is an advantage / economic moat). In a way, there is a monopoly and it's unlikely the monopoly will end.
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Post by arnyk »

If your numbers make sense, stick with them. Finding companies trading at a discount is very difficult nowadays, especially with bigger companies. Think about it, there's probably a hundred analysts out there running the same numbers on TD or MFC - they know exactly what we know, and probably more. In a lot of ways, the markets are fairly efficient for large caps.

I've begun looking at smaller cap businesses. Preferably no analysts, and illiquid enough to only be available to small retail investors with little capital. The threshold liquidity should be appropriate for your own portfolio size. My thinking is, this might put me on a more level playing field with the other guys out there. Some may have more info than me, but I'm betting a lot of them won't even be running valuations - only speculating. There's a much greater chance of mispricing at these levels. Definitely riskier.

The Canadian big banks and insurers will exist 10 years down the road. The current financial crisis certainly throws this statement into some doubt - but I still believe that they will not fail. What's happening right now is exceptional.

I took a position in LB recently. I looked past the big banks that were getting all the attention, and to the little guys. I'm figuring if the big guys are busy trying to resolve this heck of a mess, the little guys might be able to make some headway in terms of market share. There may be opportunities that the big banks are passing up that they normally wouldn't because of their current financial condition. Valuations for LB were reasonable - though most investors have clearly realized my macro idea earlier this year (it's had quite the run-up).
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Post by glennchan »

The Canadian big banks and insurers will exist 10 years down the road.
I don't think this is true. Historically, many banks have gone out of business.

One problem is that they can do stupid things with their money (e.g. buy CDOs) so it looks like they're making money when they aren't. And it can be difficult to tell if they are doing stupid things with their money (e.g. SocGen).

The other issue is that you have to figure out whether or not it's trading for less than its intrinsic value. (Which Buffet points out is hard to figure out sometimes, since you don't know whether or not they're doing stupid things with their money.) It's not enough to simply say they will exist 10 years down the road (which is uncertain)... are they underpriced?

Some banks would be worth investing in if the opportunity presents itself. e.g. Buffet invested in Wells Fargo when it was (A) priced below its assets and (B) because he felt they wouldn't do stupid things with their money.

2- I'd argue that it's a somewhat risky investment since the underlying company is volatile. At any moment the bank may disclose that it's really been losing a lot of money (e.g. subprime crisis). If you look at the prices of banks and reinsurance companies, they have cycles where they make a lot of money and then report huge losses.

The investment might also be speculative (in a value investing sense) if you cannot value the business with great certainty.
There may be opportunities that the big banks are passing up that they normally wouldn't because of their current financial condition.
I don't think there are really any good opportunities in banking. Banks receive deposits and give out (hopefully good) loans. I don't think the subprime fiasco has really affected that.

There are supposed "opportunities" in CDOs, derivatives, etc. These things have generally proven to be good/new ways of losing money.
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Post by adrian2 »

glennchan wrote:
The Canadian big banks and insurers will exist 10 years down the road.
I don't think this is true. Historically, many banks have gone out of business.
Not in Canada in the post WWII history, at least.
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Post by Bylo Selhi »

adrian2 wrote:Not in Canada in the post WWII history, at least.
To clarify: CDIC was created in 1967. Since then they have had to bail out several smaller banks and several dozen trusts or various sizes. (The last major bank failure was Home Bank in 1923.)
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Post by Peculiar_Investor »

adrian2 wrote:
glennchan wrote:
The Canadian big banks and insurers will exist 10 years down the road.
I don't think this is true. Historically, many banks have gone out of business.
Not in Canada in the post WWII history, at least.
Although technically not a bank, what about Royal Trust? The stock essentially went to zero before being bought by RBC in 1993.
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Post by adrian2 »

Peculiar_Investor wrote:Although technically not a bank, what about Royal Trust? The stock essentially went to zero before being bought by RBC in 1993.
No Canadian financial institutions in the top 5 by market cap went bankrupt since WWII. Investors in these stocks with a long enough (5 years ?) time horizon made money. This time may be different, but not IMHO.
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Post by brad911 »

I make a habit of reading Buffett directly from time to time to consider where value might occur in the markets. I found this interesting regarding the preferred shares he held (via Berkshire) in 1989 and how an investor could possibly look to his recent pref purchases (GE & GS) for his long-term intentions:

"Under almost any conditions, we expect these preferreds to return us our money plus dividends. If that is all we get, though, the result will be disappointing, because we will have given up flexibility and consequently will have missed some significant opportunities that are bound to present themselves during the decade. Under that scenario, we will have obtained only a preferred-stock yield during a period when the typical preferred stock will have held no appeal for us whatsoever. The only way Berkshire can achieve satisfactory results from its four preferred issues is to have the common stocks of the investee companies do well."
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