Successful Value Investing – Seven Pillars for Success
Pillar 1: Price
“It is better to buy a good business at a fair price than to buy a fair business at a good price.” ~Charlie Munger.
I recall listening to Warren Buffett share his view of buying business at a discount. We all like to buy companies while they are at a discount to the average historic market value. This of course has to be corrected for inflation and corporate actions such as stock splits etc. That being said, it is very important to understand that a company has a intrinsic value. This can be calculated using various methods, I tend to follow the top down approach and apply the use of Discounted Cash Flows. However, another method may be to look at the current value of the assets held by the company. Additionally, we can use ratios such as the Price to Earnings (P.E.) Ratio, Income to Assets Ratio, Current Ratio, Quick Ratio, among others.
Pillar 2: Profit
The ultimate aim of investing is to realise a profit. Therefore, profitability is very important pillar for successful value investing. Let me differentiate between profitability and profit-ability. Normally when Analyst and Investors speak of profitability, we are looking at the past performance of the company and using profitability ratios to assess how profitable the company has been. However, for successful value investing, we must consider another perspective of profitability. We must not only look at the history of the company through profitability ratios, but also through the lens of the company’s ability to realise, continuous and (hopefully) growing profits in the future.
Pillar 3: People
Many Investors, myself included, invest not only in a business but also the people. I think Management is a key metric in assessing the intrinsic value of a company. Why? Think for a moment who came up with the idea for the business, what does their track record indicate about them? Are they trustworthy? Are they competent? What vision do they have for the future of the business? Are they playing the long game? Can they endure three years in the red for the better of the company, it’s employees and it’s shareholders?
What is their motivation for being in the business concerned? Do they have interpersonal issues that could lead to the demise of the business? Who is their ideal employee? Who is their typical employee? What type of culture are they fostering in the business? In my opinion, these are all very important questions and worth investigating. Even if only on a superficial level.
Pillar 4: Practicality
This might seem like an odd criteria for successful value investing but allow me a minute to make a case. The typical “Investor” is looking for the best place to put his money. He wants it in and out in the shortest possible time, with the maximum possible return. It is for this very reason that so many “Investors” lose their money in the stock market and proceed to forever curse the infrastructure. The fundamental investor differs. The Fundamental Investor applies the question of practicality to his investment options in order to be successful. Successful value investing requires us to consider the practicality of the business. A case in point is that of SNAP Inc. In March of 2017, SNAP Inc, the parent company of social media application SNAP CHAT issue an initial public offering for 200 million shares with an invitation price of USD 17.00.
On the first day of trading the stock rose 44% (yes, you read that correctly) to USD 24.00. The practicality of SNAP’s business can be assessed by considering the fact that nearly all it’s features have been copied by Facebook, Instagram and soon WhatsApp. Furthermore, Facebook, the social media network (and by the time you read this, the Advertising Giant) owns two of SNAP’s rivals, Instagram and WhatsApp. All in all the long term prospects do not look enticing for SNAP. At the time of the IPO, the company had not yet realised a profit (see profitability) and with user growth growing at a more or less flat rate, the future income did not seem secured (see profit-ability). The following screenshot of an article from investopedia.com will allow you to run your own numbers.
The point here is that, at the time of SNAP’s IPO, the company was not a practical investment from a value investing perspective. Again, successful value investing requires us to also view our investment options from a practical point of view.
Pillar 5: Psychology of the Market
Human psychology has not changed much throughout the centuries. This is why Psychologist and Counselors remain relevant today.
Pillar 6: Performance
I do not believe it is unfair to say successful value investing is predicated primarily on the historic performance of companies.
Pillar 7: Patience
I intentionally saved this for last. The simple reason is that Patience is possibly the most important of all the pillars. I could give you countless examples of legendary value investors who have succumbed to the trap of loosing patience. Ben Graham and his student Warren Buffet have done it, Mohnish Pabrai has done it, Bill Ackman has done it, Sir John Templeton too, among many others. I do not exempt myself from that list to say I have eluded this trap, rather, I exclude myself because I am still on my #Journey to becoming a legendary value investor. The most challenging thing in successful value investing is patience. It takes quite a lot of emotional fortitude to stay the course once we have made an investing decision based solely on fundamentals. The reason for this is simply that most people are not doing that type of investing and in the short term the market will make us look like buffoons.
If you enjoyed this article or learned anything that you consider valuable kindly do one (or all) of the following.
– Like the article on https://bestyoupro.com/
– Leave a comment on the website with your greatest takeaway or post it in one of our facebook groups.
– Share the article on your favourite social media.
– Follow BestYouPRO International on Twitter: @BestYouPro
– Subscribe to BestYouPRO International to get new articles sent directly to you as soon as they are posted.
Let's Get Social