kcchongnz blog

Why value investing works? kcchongnz

kcchongnz
Publish date: Sun, 27 Apr 2014, 05:17 PM
kcchongnz
0 408
This a kcchongnz blog

Value Investing Works

"In the world of investing, being correct about something isn't at all synonymous with being proved correct right away”                Howard Marks

 

Price Vs Value

Share prices don't exist in a vacuum. Instead, they represent what it costs, at one point in time, to buy a tiny proportion of a company listed on the stock exchange - a company that employs people, produces goods or services and, hopefully, generates revenue, profit and cash flow. Alongside this quoted stock price, value investors also take account of a company's underlying, or "intrinsic" value. Unlike the stock price, you can never get an exact fix on this figure but you can sometimes make a reasonable estimate by undertaking "fundamental analysis", which involves looking at a company's financial statements over time and making an assessment of its management, markets and growth potential. Share prices, you may have noticed, vary enormously over the course of a year. But a business's revenue, profit and cash flow rarely change anything like as much as that. The reason for this is that the price of a company's shares is only a reflection of what people are willing to pay for them at any given time. Sometimes, usually when prices are rising, they're greedy. When prices fall, they become fearful and rush for the exits. All this emotion can push the share price a long way from the intrinsic value of the underlying business. Value investors aim to benefit from this by buying shares when they're trading at significantly less than their intrinsic value. Or, to put it another way, buying a dollar's worth of value for 50 cents.

 

Why value investing works

If value investing works so well, why doesn't everyone jump on the bandwagon? Not everyone is able to view movements in stock prices with the detachment that's required of a value investor; if they could, then the share market extremes caused by fear and greed would not occur. This paradox is one of the keys to the success of the value approach: the concepts are extremely simple to grasp but can be very difficult to put into action. Why? Human psychology. Most stocks tend to be priced about right much of the time. Something significant usually has to happen for a stock to become under or overpriced; a profit warning or a competitor releasing a super-duper new product, for example. In other words, an attractive opportunity for value investors is very often caused by bad news, while good news is very often the signal to head for the exits. So value investors have to be contrarian, looking for the positives when everyone else is looking at the negatives (and vice versa). Humans are hard-wired to follow the crowd, but that's usually an unprofitable course of action in the share market.

 

The other reason is related to retail investors’ emotional biases. Few retail participants in Bursa are interested in dull stocks with not much of trading activities. There is no fun watching it with little or no movement in share prices of these stocks every day. Most of them just listen to hot tips and rumours to speculate in the market without having any knowledge about investing. Those retail investors with better knowledge and experience will have an advantage. There is also this institutional imperative. Most institutional investors have no mandate investing in small capitalized firms. Fund managers are more concern about their career risks if following a winning strategy if it involves enduring long stretches of relative underperformance which does happen in the short term, but usually not in the long term. They feel that it is safer to be wrong when everyone else is losing money than to be wrong when everyone else is making money which the formula can do.

Value investing is extremely simple in theory, but tougher in practice.  If you compare the price of a stock with a confident valuation of its true worth (intrinsic value) and find you can buy it at a considerable discount (margin of safety) then you may be onto a winner. But value investing is much harder than it looks for two reasons, firstly the real intrinsic value of a company can be tricky to calculate but also the practice of buying beaten down stocks also runs contrary to almost all human instincts.  Who wants to be the guy holding the boring power generation stocks MFCB when everyone else is buying the hot stock KNMBut it’s precisely these tendencies that lead to so many investors over-reacting,  driving prices down so low that value stocks become so profitable in future.

 

How Profitable is Value Investing?

Benjamin Graham is widely regarded as the dean of value investing as well as the whole industry of Security Analysis.  This influence stems not only from his published works but also from the eventual fame and fortune of the pupils that he taught at Columbia University who included Warren Buffett. It is thanks to Graham that we have a whole catalogue of quantitative bargain stock strategies at our disposal with such obscure titles as ‘Net Net Bargains’ and ‘Net Current Asset Value Bargains’ as well as a whole ream of other concepts that we’ll explore in our course including Margin of Safety.

In a paper titled “The Super Investors of Graham and Doddsville”, Warren Buffet showed the track records of each of nine disciples of Benjamin Graham showing that they all generated annual compounded returns of between 18% and 29% over track records lasting between 14 to 30 years. Is it likely that these individuals from the same school of thought could all beat the market over a generation if the stock market was a place of luck? Warren Buffett doubted it most eloquently when he said “I'd be a bum on the street with a tin cup if the market was always efficient”.  Let’s have a look at their profit history...

Investor

No. of Yrs

Annualised

    Return

S&P / Dow

    Return

Buffett Partnership

     13

     29.5%

  7.4 % (Dow)

Walter Schloss

     28

      21.3%

   8.4%

Tweedy Browne

     16

      20%

   7%

Bill Ruane

     14

      18.2%

   10%

Charlie Munger

     14

      19.8%

    5.0% (Dow)

Pacific Partners

     18

      32.9%

    7.8%

Perlmeter Investments

     18

      23%

    7.0 % (Dow)

 

The value investing camp splits into two on this topic. Fundamental value hunters who follow Warren Buffett tend to fall into the ‘focus portfolio’ camp believing that you should put all your eggs in just a few baskets and watch them like a hawk.  An alternative approach is that espoused by the more ‘quantitative’ value farmers who seek to ‘harvest’ the value premium from the market. Graham recommended owning a portfolio of 30 bargain stocks to minimise the impact of single stocks falling into bankruptcy or distress, while Joel Greenblatt recommends a similar level of diversification in his Magic Formula strategy


Making Sense of Value Investing Principles

What should be clear now is that while intrinsic value and margin of safety make perfect sense in the context of value stock selection, defining precisely how to execute each principle requires some careful thinking and the acceptance that some nuances can only be decided by the interpretation and preference of each investor. 

 

Discussions
6 people like this. Showing 11 of 11 comments

johnny cash

please give a list of this value stocks? is it pintaras only?? do you have other picks? thanks

2014-04-27 18:26

stockoperator

Arguably those are Not involved in the REAL business world could hardly grasp the idea of Value investment with confident on a particular company. For example KC is a civil engineer and understands the Real Business of Pintaras In and Out.

2014-04-27 19:23

stockoperator

For me to involve it will be like speculating In and Out without real understanding of its Real value. When the storm comes, i will be in Self Doubt and before long i will be wiped Out.

2014-04-27 19:31

kcchongnz

Posted by johnny cash > Apr 27, 2014 06:26 PM | Report Abuse

please give a list of this value stocks? is it pintaras only?? do you have other picks? thanks

I wrote a lot about Pintaras Jaya. Seriously I am not peddling the stock. Few see my real intention of trying to educate the fundamentals about true investing here.

What will be my purpose of giving a list of value stocks here? Again not many will understand my real intention of educating people about investing in the psychological aspect. Few bother about the message in the article.

2014-04-27 19:46

stockoperator

KC takes on Pintaras has provided us the framework and research and analysis that needs to be done. There is No shortcut around it.

Ayam Tua, can you do the same thing on your Hexza and NTPM so that you understand why it is resilient and potent. IF not you would be bored down and flat out with chart and graph and everyday in and out.

Very seldom any one of us would go down such a process of so lengthy works of hunting down a company.

2014-04-27 19:52

stockoperator

KC just provides the frameworks and education and analysis of what needs to be done.

The works must be of your own then Only the company is yours forever.

2014-04-27 19:56

stockoperator

KC, anyway understanding investors profile is equivalent important. I mean their risk appetite, expectation, investment style, choice and preference so that the gap of understanding would not lead to misunderstanding and disappointment.

2014-04-27 20:10

calvintaneng

Few bother about the message in the article? The message is

BUY BELOW INTRINSIC VALUE

SELL WHEN IT RISES ABOVE INTRINSIC VALUE

OR IN SOME CASES NO NEED TO SELL AT ALL AS THEY CAN GENERATE VALUE FOR EVER

LIKE

1) THE SUEZ CANAL

2) SINGAPORE STRATEGIC LOCATION

3) SHOP LOTS IN SUNGAI WANG PLAZA

4) LITRAK - THE TOLL ROAD

5) PINTARAS AS LONG AS BUILDING BOOM CONTINUES IN MALAYSIA

2014-04-28 00:40

cytew

At least 90% of retail investors ARE NOT INVESTORS, they are traders or speculators,because they lack of patience ,most of them can not even comprehend simple financial reports mainly due to their ignorant or incapability, therefore it is pointless to tell them about Value Investing....“一将功成万骨枯,一人致富万人穷” ,要知道,一个人要成功致富,需要众多的无知和无能者間接的“辅佐”方能達成,同意吗 ?

2014-04-28 08:22

stockoperator

I would say we cant fight fear and greed the so-called dark forces, no matter how knowledgeable you are. As long as you are exposed to market long enough, you will be losing control/discipline. The market forces is too big for us to maintain a single investing plan.

What should we do then? Not really sit tight as i would doubt you will be able to sit tight as well But Walk far far away and No news from the market.

It is the same thing you Walk away from alcohol, cigarette, gambling and so on.

2014-04-28 12:52

johnny cash

Posted by kcchongnz > Apr 27, 2014 07:46 PM | Report Abuse

Posted by johnny cash > Apr 27, 2014 06:26 PM | Report Abuse

please give a list of this value stocks? is it pintaras only?? do you have other picks? thanks

I wrote a lot about Pintaras Jaya. Seriously I am not peddling the stock. Few see my real intention of trying to educate the fundamentals about true investing here.

What will be my purpose of giving a list of value stocks here? Again not many will understand my real intention of educating people about investing in the psychological aspect. Few bother about the message in the article.




thanks for the reply, i understand now your style on value investing. thanks sir

2014-04-28 12:56

Post a Comment