We often heard about stock trading, stocks market, buy low sell high, high-risk high return, low-risk low return, but we seldom heard about the stocks market through Value Investing.
Value investing is not trading stocks, do not be a daily stocks trader, that’s the job for brokers but we should be a Value Investor, we do not trade stocks DAILY by looking at the stock market news and the up and down charts, do not trade stocks base on financial advisers or brokers’ advice.
Instead of doing all the above, we learn to be a value investor.
1. What Is Value Investing?
Value investing is a method that choosing the good and profitable stocks that are listed in the market for less than their current intrinsic or book value. It means the stock price is cheaper than the actual overall business values. Value investors that we want to be is to be able to actively filter and screen out stocks that is being underestimated.
As the economy and market overreacted most of the time on a daily basis to the general big and small news and reflecting in the stock price movements. Which, it not direct impact on a company’s long term fundamentals in the long run. Huge volume of tradings that overreacted by the market up and down, that opens up opportunities for us to be able to have a position in the stock market by purchasing stocks at the discounted prices. Isn’t that what we always do? It is to do shopping when it’s on SALE.
2. How Warren Buffett uses it?
Value investing is known to be practiced by Warren Buffett long time ago, some other good investors like Benjamin Graham, professor and mentor of Warren Buffett, David Dodd, Charlie Munger vice chairman of Berkshire Hathaway, Warren Buffett’s right-hand man, Christopher Browne (Graham student), and billionaire hedge-fund manager, Seth Klarman.
Buffett and Graham both are known using Value Investing Strategy, they constantly looking for undervalued stocks (stocks that on sale) that have good cash flows, good fundamentals, have economic moats, sustainable competitive advantages such as brand name, network effects, or switching costs.
Economic Moats play an important role, as Buffett prefers to understand the business when he invests, companies like Coca-Cola, insurance, banking companies like Wells Fargo, and he also looks into sectors like healthcare, industrial and energy.
Warren Buffett – “It is much better to buy a wonderful company at a fair price than a fair company at a wonderful price,”
Economic Moats simply is what we can related to in our daily life. Observation of human behaviors, what they often use, purchase and consume. For example, Coca-Cola, a well-known brand that being tied-up with Mcdonald’s, famous fast-food chain, these two giants are most average customers would likely choose, over brands that they’ve seldom heard of.
Warren Buffett recommends investing only in industries you have personally worked in, or whose consumer goods you are familiar with, like cars, clothes, appliances, and food.
3. How Value Investing Works?
Why women are better investors than men? Simply because women are better at finding goods with high values but only buy them when the price has come down. That’s the happiest moment when the sales is on.
The simple concept of value investing is pretty much the same. If we know the actual value of something that we thirst to have, the same time we can save a lot of money, and that’s the happiest moment when we buy it during sales period.
Value investing works similarly, regardless of how often the company’s stock price can go up and down but the intrinsic value of the business should always remain the same. The stock market affecting by the economy demand and causing fluctuations, what we believe it’s good doesn’t change the way we invest through our due diligence.
Often times, stock markets go on sale usually is unannounced. Unfortunately, nobody is able to predict when it will come nor when it will be ending. As value investors, the more we practice, the more we know where to find more information to support the fact that when buying them at a discount price. Continue doing it for the long-term 10 to 20 years and be patient, we will be able to grow our money exponentially.
4. Intrinsic Value
When is the discounted price? How cheap is cheap? When shares are undervalued? Investors use various metrics to evaluate the intrinsic value of a stock.
They started with doing financial analysis such as going through the fundamental of a company, their financial status, yearly revenue, earnings per share, how healthy is their cash flow, as well as the brand research, business model, competitive advantage and who is their target market.
It might sound a very tedious process for all of us, but if you think of Mcdonald’s, Coke-cola and Starbucks again, they are just part of our daily life. It is not difficult at all to understand their business. No matter what economic situation we are at, we still consume the same fast food and coffee. That’s the basic knowledge or general information that we need to obtain.
There are various metrics you can use that include:
- Price-to-book (P/B) or the investors call it book value, which measures the value of a company’s assets and comparing them to the stock price. If the price is lower than the value of the assets, the stock is undervalued especially when the company is not dealing with financial hardship.
- Price-to-earnings (P/E) ratio is the ratio of a company’s stock price to the company’s earnings per share, it is used to find out whether they are overvalued or undervalued.
- Free Cash Flow, cash that is generated from the business after the costs of expenditures and operation costs have been deducted. Remaining cash is the free cash flow that will be used to invest in other business, acquisition, and expansions, clear the bank debt or any kind of debt, pay dividends to the shareholders and issue share buybacks from shareholders.
5. Don’t Follow The Hearsay
Most of the time people invest irrationally, buying in when the market is doing well, selling in fear when the market is going down, they simply just have no patience to wait for the stock price to do up again in the long run.
So instead of wait for it so come back up, they rather take certain losses by selling it. Unfortunately, enormous investors behaving this way causes the market having excessive movements.
Value investors don’t follow the herd. When many are buying in (hopeful), they are often exiting the market or not doing anything. When everyone is selling (fearful), they are buying and keeping whatever stocks that they have for long term investment.
Regardless of what’s on the news, what are the people saying, only focus on the company fundamental, the hidden part of the iceberg.
After 6 years of value investing in the stock market, it was not an all-time-winning investment. I made the aforementioned mistakes in 2016 by putting many eggs in the same basket, acted based on hearsay. I lost a big chunk of money that I had made in the past 2 years, fortunately, I was able to keep my initial capital.
The following year I restart again and make back my course fee again and slowly growing year by year. The learning curve, learning from mistakes is necessary. Situations make us a wiser investor.
Diversification is important to protect your portfolio. Owning multiple stocks, from different indexes, variety of companies even explore into different sectors is a better way to safeguard your money.
So that if anything happens to a certain index or specific industry, only 1 part of your portfolio is affected. Investment manager Christopher H. Browne recommends owning 10 stocks in his book, value investor Benjamin Graham suggested 10 to 30 companies are enough to create a diversified portfolio.
7. Observe Your Emotions
It is hard for you to imagine now how our emotions will affect the way we invest. Until when you have taken actions and you have real money in the stock market, and all the stocks are high in price and your money is growing.
You will encounter a dilemma whether to keep holding it or to take the profit and sell them.
Vice versa, when the market is down, all running numbers are red on your screens, you will feel anxious, worry, even you might not sleep well at night. All these will happen to all of us and it is normal.
This is the time we all should observe how we feel, and perhaps read this blog again and again. Why being a long term value investor is important, diversification is mandatory, not to be herd-mentality investors.
8. Long-term Investors are The Winners
Warren Buffett once said, “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
According to the past track records, those who bought the stocks 10 years ago, and leave it there, doing nothing fancy, made the most profit. They only sell it when they need the money for retirement, otherwise, the periodical up and down is cyclical.
- Value investing: Choosing the good and profitable stocks listed in the market for less than their current intrinsic or book value.
- Economic moats, do what you can understand
- Metrics to find out value stocks include: Price-to-book (P/B), Price-to-earnings (P/E) ratio, Free Cash Flow
- Don’t follow the hearsay
- Observe your emotions
- Be a long-term value investor