What exactly is value investing?

Most people have the opinion that value investing is buying cheap stocks – those that are trading at low price to earnings or low price to book value. I am not surprised that some people even think that value investing is buying low-priced stocks, those penny stocks selling for a few cents.

Of late I even heard a guy saying that value investing is to buy any of those 30 component stocks forming the FBM KLCI, those with big capitalization. He incessantly saying that investing other than those big capitalized stocks, for example, investing in stocks in the ACE market is gambling and fraudulent. You can read his comments repeated scores of times in this thread here.

http://klse.i3investor.com/blogs/kcchongnz/120082.jsp

This is new to me and I am sure very foreign to most true value investors too. But how far is it true?

Just fathom that; how can one find good value in Genting, Maybank, public Bank, IOI, KLK, Maxis, BAT, etc. when every fund manager must own them?

Yes, buying the stocks above can be value investing too, only when they are selling cheap, and only when there is a big sale in the market when there is a crisis, or a temporary set-back to their earnings. But generally, they are often already fully valued, or even overvalued because of the action of bidding up their prices by all the fund managers and institutional investors.

On the contrary, almost all value investors look at the forgotten and beaten path, trying to find values where others, i.e. the fund managers, institutional investors are not interested in because of the sheer size of their fund under management, and have no mandate to invest in. Or like that guy above who has not the slightest idea of what value investing is, and hence avoid looking at them at all costs.

Isn’t this the purpose of value investing, to buy a stock when it is selling cheap?

What did Buffett say about value investing?

In his 1992 letter to Berkshire Hathaway shareholders, Warren Buffett wrote…

“We think the very term ‘value investing’ is redundant. What is ‘investing’ if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labelled speculation (which is neither illegal, immoral nor – in our view – financially fattening).”

“Whether appropriate or not, the term ‘value investing’ is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments.”

So, it’s the ‘processes of picking up bargain stocks that value investing is all about. It is not as simplistic as some investors think. You must know what you are getting into.

Charlie Munger, Berkshire Hathaway’s Vice Chairman, who has influenced Buffet in purchase of Coca Cola and other seemingly high price acquisitions mentioned it out clearly.

“All intelligent investing is value investing - acquiring more than you are paying for. You must value the business in order to value the stock.” 

Munger explained further,

“You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.”

So, value investing is intelligent investing. Value investing is about looking for a mispriced gamble, getting more than you are paying for. It is not just about buying growth stocks, or cheap stocks.  

It is not about if the stock is listed in the DJI, S&P 500, NASDAQ, or Russel 5000 etc. It is not about if it is listed in the Main Board, or the ACE Market of Bursa.

Seth Klarmen said,

“Picking through the crumbs left by investment elephants can be rewarding.”

Value investors follow a proven process, to buy good companies selling at reasonable or cheap price. You must know enough about the business and hence the value the business. The figure below gives us an idea how the thought and analitical process is,

It is still a gamble, nothing is for sure in this world except death and taxes, but by knowing the business and its value well enough, the probability of winning is higher. yes, it is a probabilistic outcome.

Value investing is both a mind-set as well as a rigorous discipline.

Value investing focuses not only on how much money one can make from the market, knowing that everybody is trying to do that and hence it is not easy, but also avoid mistakes, resisting market fads, and hence the risks of losing with the investing motto of,

“Focus on the downside and the upside will take care of itself”     Mark Sellers

Value investing is considered as a marathon, with winners and losers identified over a period of several years, not days, weeks or months, although value investors may not keep investment for ten years or decades.

How profitable is value investing?

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...

How fantastic have been the outcomes of some super investors in their value investing endeavour. Take for example Walter Schloss. $100000 invested by him for 28 years earnings a CAR of 21.3% became $22.3m, compared to $957k invested in the broad S&P 500 during the same period.

In his latest book, “The value Investors, Lessons from the World’s Top Fund Managers” published in 2012, Ronald W. Chan interviewed twelve top fund managers from US, Europe, and Asia using various forms of value investing expounded by the Super Investors of Graham and Doddsville. The evidences showed it has worked all over the world.

I just listen to the presentation of Dato Sri Cheah Cheng Hye of Value Partners of Hong Kong, who is well known as Warren Buffett of Asia this morning. He started to become famous was when he started his fund invested in small and mid-sized capitalization stocks, which institutional investors scorned of, and made barn-storming return. His USD5m AUM 23 years ago has grown to USD16b now. The cumulative return of the fund is 2530%, or a CAGR of 15.5%, even after going through a few crisis such as the major ones in Internet Bubble in 2001, and the subprime housing crisis in the US in 2008, and a few minor ones.

We also have our Malaysian super investor, Fong SL, or Cold Eye. He has been obtaining fantastic return from his value investing. And there are many of his stocks are small capitalized stocks.

But does value investing work for me in Bursa? What and where are the evidence? This is always a pertinent question.

I had just written an article, “Luck or Skill, who is lucky and who is skillful?” in i3investor in the link below,

http://klse.i3investor.com/blogs/kcchongnz/119863.jsp

In the link above, it shows a portfolio of 10 stocks of mine, named “GE13 Watch” set up in i3investor on the same date on 23^rd January 2013, and another one, “Stock Pick Challenge 2H 2013” on 1^st August 2013. The stocks in there are all small and medium capitalization stocks. There is nothing to be shameful about when you are investing in good companies at cheap prices.

On the first one, “GE13 Watch”, this is the summary of the total return as on today on 6^th April 2017,

“During this period, the average return of the portfolio of ten stocks is 143.3%, or a median return of 92.5%, widely out-performed the gain of the broad market KLCI of just 20.6%. The compounded annual return of the portfolio (CAR) is high at 24%”.

On the second portfolio, “Stock Pick Challenge 2103 2H”,

“During this period, the return of the broad market was up by 8.4%. The portfolio of stocks out-performed the broad KLSE market with an average return of 145%, or a median of 71%. The CAR of the portfolio is 30%, even better than the “GE13 Stock Watch” above. if I could put aside RM1000 a month and invest in the share market for a return of 30%, I would have accumulated a total of about RM9m in 30 years, a huge sum of money.”

There were a few stocks which were, or once were from the Mesdaq or ACE market before such as Willow, Datasonic, Homeritz, Fibon, Jobstreet etc. they were all barn-stormers, with multi-bagger returns of 505%, 482%, 159%, 200% respectively, in just 3 and a half years.

These are longer duration portfolio of more than 4 years. I have a number of shorter-term portfolios. They behave the same, making outsized return, all of them. Value investing is supposed to work for long-term. It also works for me in the short-term, so far, without fail. You can find them in i3investor where I share my investing knowledge and experience all these years.

[Flintstones Hi KC, have you spot any bargains in the market lately? Looking forward to your next stock call]

Sorry, I seldom share stock pick in public forum any more, for the simple reason that I can’t be right all the time. if I am right, even every time, you won’t thank me. But if I am wrong just once, you will scorn and ridicule me. So, what for?

However, I do have a stock pick service giving to my past and present investment course participants. This service come with detail analysis and valuation of stock picks, plus carefully selected watch lists. They can evaluate and understand my investment thesis and make up their own decision. They don't blindly buy what I have written. I am glad to say that a number of them have obtained about 30% return from less than a year ago, with the highest at 33+%.

Hence, at least as it is now, no one can ridicule with with statement like this,

[Posted by Flintstones > Dec 2, 2016 12:05 PM | Report Abuse

Posted by paperplane2016 > Dec 2, 2016 12:03 PM | Report Abuse
hahahaha.,.,.,.,.,.,kc chong write fancy FA studies, but still fail to make money.
Reason: Tak ADA COMMON SENSE mah!!!!
hahahaaaaaaaaaaaaaaaa
He probably makes more money from his followers lah]

Anyway, that is how value investing is rewarded; willing to drive down the forgotten and beaten track.

But beware, it is true that there are many traps in the ACE market too, and many people do lose their pants there; not because these stocks are listed in ACE, but because they know nothing in investing, and merely listening to rumours, hopes, hypes and fads. There are easier to be manipulating and hence more pump and dump activities there too.

Is Value Investing Easy?

“Investing is not easy, anyone thinks it is easy is stupid.” – Charles Munger

Most new “value investors” are upset after one week, mad after one month, and gone after one year when value investing doesn’t work. In fact, most investors aren’t cut out for value investing. This is simply because value investing can get really painful, and human nature shrinks from pain. Making money on value stocks – which is the goal of every value investor – is harder than it sounds and can take years to play out.

In fact, identifying a value stock and buying it is a relatively easier proposition, provided you must, at the minimum, know the language of business, that is understand and know how to read financial statements, understand shareholder value creation, and able to do some valuations. But value investing is difficult because…

• You need to have patience, and a lot of it
• You must be disciplined
• You must mind your behaviour
• You must know when to go against the crowd, to be contrarian, and you must be right about it most of the time
• You must read a lot (annual reports, investing books etc.)

In all, value investing requires hard work. This is probably the reason you won’t find many value investors out there. But whoever has had the patience to practice value investing in its real form, has done wonders for his stock portfolio. My documented personal experience in i3investor has proven so. Yes, it does all the time.

Why not? Value investing is intuitive, plauseble, buying a basket of good companies when they are selling cheap. Your job is to have the necessary knowledge and experience in how to identify good companies, and what is cheapness means.

So, do you want to become a value investor?

Happy value investing.

K C Chong (ckc13invest@gmail.com)