Value investing a painful process, but pays dividends
Price is what you pay while value is what you get. So, in my earlier discussion, I was mentioning about the non-quantitative or qualitative factors like management team, accounting consistency, etc. along with various values or ratios that are evident in the balance sheet (quantitative) but, market (idealistically being rational) would involve in price discovery of the security and hence, is the c
Price is what you pay while value is what you get. So, in my earlier discussion, I was mentioning about the non-quantitative or qualitative factors like management team, accounting consistency, etc. along with various values or ratios that are evident in the balance sheet (quantitative) but, market (idealistically being rational) would involve in price discovery of the security and hence, is the correct method of valuation.
But the reality is a bit different and includes a large amount of whim and fancies of the investors along with their emotional outbursts (both positive and negative). So, doesn’t all these get inbuilt in the pursuit of finding the right price. Probably yes or may be no because price is arbitrary and very subjective to each of the investors’ perspectives & analysis. What one might see as an over-valued stock would be seen as an under-valued by another. This is how diverse one perceives the same data and interprets into drawing different conclusions.
So, even if the company is being governed by a bad management, driven on unproductive process and inefficient systems, the current price of the stock would reflect if these deficiencies are known to the public.
So, if the price is discounted by the market forces if the company is going through a bad phase or if a company altogether is a bad one. For instance, in the case of Kingfisher Airlines, the stock was giving feelers as the news rolled about the debt woes. But, much before this news started to float the series of quarterly results unraveled the stock. It may not be true with all the cases where financial innovation is involved like that of the Satyam Computers, leading ultimately to fall from grace.
Despite my argument of price as the single most important factor in choosing a stock, I do believe it’s difficult to identify the right price for any stock. Thus, value investing is a painful and grueling process where the success is to have everyone agree with you, at a very later stage. This is because a low valued stock could mean many things and may be not all the factors for the current price reflection are captured in it.
This could be like trying to hold a falling knife and most likely to get hurt. Meb Faber has once joked about cheaper stocks as, “what do you call a market that is down 90 per cent? That’s a market that was down 80 per cent, then proceeded to go down 50 per cent more”.
The need of the hour is buying a stock at the right price or rather valuing at the right price as that would translate into one’s margin of safety. This is because, if you could identify the intrinsic value of a stock and if you see the price is at a discount to that value, then you’re in for a gold mine. This would stand in good stead despite some bad news or negative results as your entry is still lower than its intrinsic value. That’s why value investing would triumph all, but also is very difficult subject to deal with.
It’s harder because you’ll have to figure out the things much clearly and precisely than most of the others as this discovery could lead to attract more investors and the arbitrage would be lost. Also, it’s your ability to understand the problem, for that matter define a problem. This ‘problem’ should be solvable and the company has the resources or has the wherewithal to drive for a solution. And most of all as an investor, you should identify that the problem could be solvable by the company management.
Howard Marks describes this as the second level thinking. For instance, Amazon is a very good and adaptive company, a fact known to most people. That’s the first-level thinking. Now, could they be as successful as they were in all the categories or lines of business they enter then that’s the second-level thinking and how do you figure that out? Wishful thinking or an evolved process. Probably a combination of the both but there’s no formula to arrive at this. It’s constant trial-error method with improvements at each iteration.
By: K Naresh Kumar
(The author is co-founder of ‘Wealocity’, a wealth management firm and could be reached at firstname.lastname@example.org)