Approaches To And Essentials Of Value Investing by CSInvesting

Value Investing

Essentials of Value Investing

Long-Term Fundamental (Look at Underlying Businesses)

Specific Premises:

  • Mr. Market is a Strange Guy
    • Prices diverge regularly from fundamental values
  • You Can Buy Underpriced Stocks
    • Fundamental values are often measurable
  • Fundamental Value Determines Future Price
    • Buying underpriced stocks plus patience implies superior returns

Value Investing in Practice

Long-Term Fundamental (Look at Underlying Businesses)

1) Look Intelligently for Value Opportunities (low P/E, M/B)

  • Mr. Market is not Crazy about Everything
  • This is the first step not to be confused with Value Investing

2) Know What You Know

  • Not All Value is Measurable
  • Not All Value is Measurable By You (Circle of Competence)

3) You Don’t Have to Swing

  • Value Implies Concentration not Diversification (look for Margin of Safety)
  • At Worst, Buy the Market

Value Investing the Approach

Value Investing

Search Criteria

  • Obscure

– Small Capitalization

– Spin-Offs

– Boring (Low Analyst Coverage)

  • Undesirable

– Financial Distress, Bankruptcy
– Low Growth, Low P/E, Low M/B
– Industry Problems (Bad Loans, Regulatory Threat, Overcapacity)
– Company Problem (Lawsuit, Poor Subsidiary Performance, Poor Year)
– Disappointing (Long-Term Under performance)

  • Supply, Demand Imbalance – RTC

– Privatizations

Stocks as Underpriced Assets

  • Stocks historically outperform bonds, etc.
  • Stocks are not that much more risky

But today…

Stocks: E/P = 4% + 1½ % = 5½ % vs. 11%

Inflation Historical

Bonds: 5% vs. 3½ % at comparable inflation rates

Notes: 4 ½ % vs. 2%

Stock under valuation not so clear

Systematic Biases

1. Institutional

  • Herding – Minimize Deviations
  • Window Dressing (January Effect)
  • Blockbusters

2. Individual

  • Loss Aversion
  • Hindsight Bias
  • Lotteries

Loss Aversion – Example

  • In addition to whatever you own, you have been given $1000. Choose Between:

– $1000 with Prob .5 $ 0 with Prob .5

– $500 with Certainty

  • In addition to whatever you own, you have been given $2000. Choose between:

– -$1000 with Prob .5 $ 0 with Prob .5

– -$500 with Certainty

Earning Power Value Adjustments

“Earnings” = EBIT (From Financial Statement)

+ One Time Charge Adjustment (if charges before tax average 20% of EBIT – 5 years – then reduce EBIT by 20%)

+ Cyclical Adjustment (calculate peak-to-trough EBIT variation – say Screenshot_1 20% of average. If a peak subtract 29% of EBIT)

+ Tax Adjustment (apply average tax rate to EBIT – debt tax shield in WACC)

+ Depreciation Adjustment (Depr + Amort – Zero Growth Capex)

+ Subsidiary Earnings Adjustments

+ Other Adjustments (Temporary Problem, Unused Pricing Power).

See full slides below.