Most everything I write about is based on my belief in value investing as a sound, prudent and profitable long-term investing strategy. At its core, value investing relates to getting value on your money with investing just as it would to getting value for anything you would purchase. I feel safe in saying that no one wants to pay more than they should for anything that they purchase. This would apply to the basic necessities of food, clothing and shelter, and everything else that we would want to buy. Consequently, I don’t think it should be any different when we are buying stocks.
In this regard, most people execute a rather sane and simple strategy when purchasing most things. Intelligent shoppers are always on-the-lookout for bargains or sales. Moreover, most intelligent shoppers have a general idea of what the merchandise they are desirous of purchasing is worth. As a result, they are excited and appreciative when they see merchandise they want selling at a bargain price. Ironically, this seems to hold true for most every shopper except most common stock shoppers. I have long found it curious that common stock investors seem to hate it when their stocks go on sale.
Many times in the past I have utilized the following metaphor to illustrate my frustration with many common stock shoppers that I have personally talked to. Imagine for a moment that you pulled up to your favorite retail store and noticed that the parking lot was full. As a result, you had to circle the lot many times just to find a place to park. When you finally entered the store, you noticed that every aisle was jam-packed with people with full shopping carts feverishly pulling merchandise off the shelves. It could only be described as a shopping frenzy.
At that moment, something odd happened. The manager of the store got on the intercom and announced to all the customers in the store that the store wanted to reward their loyal shoppers. For the next hour the manager said everything in the store is going to be marked down 50% off. Before the store manager’s words were barely out of his mouth, you noticed something remarkable. Every shopper in the store instantly abandoned their already-full shopping carts and ran out to their cars and into the parking lot.
[drizzle]Fortunately, the store manager immediately came to his senses and made another announcement through speakers located in the parking lot area. He apologized profusely, rescinded his half off sale, and further announced that if the shoppers would come back the price of everything in the store would be marked up 50% above what the price was when the shoppers were in their shopping frenzy. With this announcement, the shoppers jumped out of their cars and stormed the doors of the store and once again engaged in a buying frenzy that was even more intense than it was just before they left.
If you think about it, the stock market is the only market on earth where shoppers routinely behave this way. When stock prices are high and inflated, people can’t seem to get enough overvalued securities to add to their portfolios. However, when those same companies go on sale at significant discounts to true value, it’s as if investors are saying they will not by that cheap stuff.
I can only surmise that common stock shoppers behave this way for two important reasons. First of all, they are heavily influenced, and even emotionally traumatized when the price of the stock they own is dropping. Consequently, they must believe that someone knows more than they do about the stock and this engenders fear and anxiety. In my opinion, the second reason might be that they are over-complicating and/or over-thinking their analysis. My experience gives me great confidence that the first reason is valid, and anecdotal experience from talking with numerous investors also suggests that my second reason plays a major role.
With this in mind, this article will present my approach on how investors can simplify their research and due diligence process on common stocks. When I was in the Army, they taught me the “K.I.S.S.” principle: Keep It Simple Stupid. I’m sure most of you have heard that expression before, and this article will present my views on how it can be applied to researching and assessing the fair value of common stocks. To be clear, I will be sharing my personal approach to simplifying how I research and analyze the fair value of any stock I’m interested in.
How Do You Simplify the Research Process: Start by Asking the Big Questions?
Big Question Number 1: Will the company remain an ongoing concern?
Since value investing implies the long-term ownership of good businesses, the most important thing I want to be comfortable with before I invest is whether or not I believe the business is viable longer term. Stated more simply, am I comfortable that the company I am examining is in no danger of going bankrupt or out of business in the near future? I’m not looking for precise growth forecasts at this point; I’m simply asking myself whether or not I believe the business will be around long enough to make me some money.
This greatly simplifies the research process and simultaneously engenders confidence in the investment decision. The simple knowledge that my business is strong enough to survive reduces the anxiety that short-term stock price volatility engenders. Furthermore, this helps me realize that I own a valuable asset regardless of whether other people are currently buying or selling it. Since I’m not worried about the survival of the business, I can have the confidence to let stock price volatility run its course.
Furthermore, true value investors buy the business, not the stock. This is not a trivial statement and represents one of the most important keys to implementing a successful value investment strategy. Almost by definition, investing in a business implies the desire to hold the investment for a long period of time. In the real world, people do not trade businesses. However, in the real world, there are many people that do trade stocks. Since business owners are not planning on selling in the near future, daily price fluctuations can and should be ignored. On the other hand, short-term price volatility can and often does create a lot of anxiety in the minds of active traders.
Big Question Number 2: Do I anticipate that the business will grow long-term or shrink?
I believe that many investors complicate their stock research process through attempting to be too precise, especially with their future forecasts. For example, investors can find specific analyst estimates on most every significant publicly-traded company on the major stock exchanges. These estimates will often include specific earnings numbers for the next few years, and additionally a longer-term forecast for earnings growth rates.
Although I think it’s rational to attempt to have some idea of how fast the company you’re investing can grow, this does not need to be as precise as many investors want or need it to be. To me, it’s significantly easier and more relevant to hold a more general view of the future prospects of a business. In other words, before I stress too much about attempting to forecast