Value investing is based on buying securities that appear to be low in price or cheap using some form of fundamental analysis. According to Benjamin Graham, value investing is knowing the intrinsic value of common stock and comparing it to the market price. Buy it when its value is greater than the price and sell it when the price is greater than its value. It was first taught by Graham at Columbia Business School in 1928 and developed in 1934 in Textual Security Analysis. The most famous book, The Intelligent Investor, first published in 1949, talks about strategies on how to successfully use value investing in the stock market. Value stocks typically have a low price-to-earnings ratio, a high dividend yield and a low P/BV ratio.
P/E stands for price earnings ratio. How much do you pay for a company and how much do you earn? How long will it take to recover your capital? An AP/E of five times means assuming earnings stay the same, it will take you five years to get your capital back. Its inverse, one divided by five, means you’ll make about 20 percent annually.
The price-to-book ratio indicates the price a company paid for its net book value, or stockholders’ equity. An AP/BV ratio less than 1 means that you are paying less than the net worth or net assets of the company while higher than 1 means that you are paying more than the net assets of the company reported in the financial statements.
Apart from buying undervalued securities and apart from the blue-chip stocks, here are some of the strategies that investors use:
Play the balance sheet. Companies that trade for less than the net asset value on their balance sheet. They are also called network networks.
Turnarounds are companies that have been hit by a downturn and are trying to regain their profitability. It is a bit tricky but not impossible to spot.
Special situations or exercises according to Chapter 15 of The Intelligent Investor book. It is an umbrella class of stocks whose financial results depend on corporate actions rather than market demand. Examples include bidding, divestitures and mergers.
Aside from Warren Buffett and Charlie Munger, there are many other successful investors who also use the value investing approach. Some of them are mentioned below:
Philippe Carrett managed the Payoneer Fund for 55 years and during that time turned $10,000 into $8 million.
Walter Schloss, despite not attending college, has returned an average of 15 percent a year for nearly 60 years for 10 percent of the S&P.
Joel Greenblatt, who ran Gotham Capital for nearly 10 years and is the author of You Can Be a Stock Market Genius, has an annual return of 50 percent.
There’s also Li Lu, Mohnish Pabrai, Michael Burry, and Seth Klarman.
Although I’ve been using value investing since the beginning, I only started officially registering it a decade ago. From June 2011 to December 2021, the PSE had a compound annual return of 5 percent. During this period, my value portfolio has generated a compound annual return of 17.5 percent. My average position size is between 10 percent to 30 percent per share. Here are some of the accomplishments of more than a decade of value investing:
Criticism is the center.
Using a value approach will result in unequal returns. There will be underperformance and outperformance compared to the benchmark every year. But in the long term, the investment should be able to outperform the index.
Value tends to underperform during bull periods and outperform during bearish periods.
The biggest returns have been achieved by taking advantage of pessimism such as the subprime mortgage crash of 2008 and the pandemic panic of 2020.
Recognizing the error, selling and reducing losses is sometimes necessary to protect capital.
It is easier to achieve higher returns by managing a small amount of capital than by managing a larger amount.
Finding great companies and keeping them for a long time is one of the secret recipes for easy outperformance.
Opportunities will always be there. So, you don’t have to be afraid of missing out.
Patience is an essential component of a value investment. A value investor should wait for the right price, and simply stay with cash when no good investments are available. As Graham said, make the stock market your slave, not your master.
You only need a few winners to outperform provided you manage your risks and minimize your losses.
Luck will always have a role in your return. But your knowledge and skills will determine superior performance in the long run.
The intrinsic value is more of a range than a specific number. It’s better to be almost right than completely wrong.
Although we want a business to thrive forever, the reality is that the fundamentals of a business can change as well. When the realities change, so do we.
Take care of the downside and the upside will take care of itself.
There is no certainty, only probabilities.
Josefino R Gomez is a Registered Financial Planner with the RFP Philippines. To learn more about personal financial planning, attend RFP 99 in January 2023. For inquiries, email [email protected] Or send a text message to 09176248110.