What is Value Investing?

Value Investing

What is Value Investing?

Warren Buffet defined value investing in the 1977 Berkshire Hathaway annual letter to shareholders: “We select our marketable equity securities in much the way we would evaluate a business for acquisition in its entirety. We want the business to be one (a) that we can understand; (b) with favorable long-term prospects; (c) operated by honest and competent people; and (d) available at a very attractive price.”

Fifteen years later in the 1992 annual letter to the shareholders of Berkshire Hathaway Inc., he added, “We have seen cause to make only one change in this creed: Because of both market conditions and our size, we now substitute ‘an attractive price’ for ‘a very attractive price’.” Since most of us aren’t the size of Berkshire Hathaway let’s continue to use “very attractive price”.

How to value invest?

Transitory factors can create a large disparity between intrinsic value (true worth) and a company’s stock price but the intrinsic value is eventually recognized in the marketplace over time, often not as fast as we like. So patience is needed.

Look for the most compelling values by searching, reading profusely, following known value experts for ideas and then do your own analysis to estimate intrinsic value. Buy the best opportunities selling at large discounts regardless of size. By being patient and acting like an owner of the company, over time when business prospects improve or intrinsic value is recognized, the market place will narrow the valuation gap. Monitor the company continuously to determine progress or needed changes to the investment thesis.

Each investment opportunity is unique so one size does not fit all, but these guidelines should always part of the value investing approach:

1. Rule number one: avoid permanent loss of capital.
2. Focus on pockets of market inefficiency.
3. Seek to invest in companies that:
    Offer significant appreciation potential to intrinsic value.
    With strong fundamental prospects.
    A catalyst to improve prospects with time.
    That meets Warren Buffett’s investment principles.
4. Identify opportunities where the intrinsic value is calculable within my circle of competence.
5. Invest in companies where the market price is preferably at least 50% below intrinsic value.
6. Certain “Core Value” companies may be purchased at market prices at least 30% below intrinsic value.
7. Cash is a byproduct of investment opportunities and an alternative to permanent capital loss.

Specific Fundamental Criteria Include the Following:
    Low price-to-book value
    Low price-to-earnings (current and projected)
    Low price-to-sales
    Low total enterprise value to EBITDA
    Total debt less than shareholders’ equity

Comments

  1. Ed biagini says

    Hi George,
    Great website, loads of great information. I’m working on my Masters in Finance and constantly get into debates with my professors about the Efficient Market Theory. You described my issues with EMT very well and I plan on using your points for colorful discussions in my classes.
    One of my main interests is discounted cash flow analysis and seeing how different investors use different models. I was curious if you use DCF to estimate intrinsic value, and if so, what model do you use?

    Keep up the great work!

    Best,
    Ed

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