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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Want to follow in Warren Buffett's investing footprints? Value Investing For Dummies, 2nd Edition, explains what value investing is and how to incorporate it into your overall investment strategy. It presents a simple, straightforward way to apply proven investment principles, spot good deals, and produce extraordinary returns. This plain-English guide reveals the secrets of how to value stocks, decide when the price is right, and make your move. You'll find out why a good deal is a good deal, no matter what the bulls and bears say, get tips in investing during jittery times, and understand how to detect hidden agendas in financial reports. And, you'll uncover the keys to identifying the truly good businesses with enduring and growing value that continually outperform both their competition and the market as a whole. Discover how to: * Understand financial investments * View markets like a value investor * Assess a company's value * Make use of value investing resources * Incorporate fundamentals and intangibles * Make the most of funds, REITs, and ETFs * Develop your own investing style * Figure out what a financial statement is really telling you * Decipher earnings and cash-flow statements * Detect irrational exuberance in company publications * Make a value judgment and decide when to buy Complete with helpful lists of the telltale signs of value and "unvalue," as well as the habits of highly successful value investors, Value Investing For Dummies, 2nd Edition, could be the smartest investment you'll ever make!
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Veröffentlichungsjahr: 2011
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Value Investing For Dummies, 2nd Edition
by Peter J. Sander and Janet Haley
Value Investing For Dummies, 2nd Edition®
Published byWiley Publishing, Inc.111 River St.Hoboken, NJ 07030-5774www.wiley.com
Copyright © 2008 by Wiley Publishing, Inc., Indianapolis, Indiana
Published by Wiley Publishing, Inc., Indianapolis, Indiana
Published simultaneously in Canada
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About the Authors
Peter J. Sander is a professional author, researcher, and investor living in Granite Bay, California. His 15 personal finance and location reference book titles include The 250 Personal Finance Questions Everybody Should Ask, Everything Personal Finance, and the Frommer’s®Cities Ranked & Rated series. He has developed over 150 columns for MarketWatch and TheStreet.com. His education includes an MBA from Indiana University, he has completed Certified Financial Planner (CFP®) education and testing requirements, and his experience includes 20 years as a marketing program manager for a Fortune 50 technology firm and over 40 years of active investing.
Janet Haley CFP, CMFC is a securities industry professional and has a bachelor’s degree in international business and political science from Marymount College.
Dedication
I dedicate this book to do-it-yourselfers and especially do-it-yourself investors everywhere, and to those who recognize the value of knowing what questions to ask even if they don’t do it all themselves. And, it would be impossible to do a project like this without recognizing the master himself, Warren Buffett, who has so clearly demonstrated that successful investing is a matter of wisdom, not just information or knowledge, and most certainly not guesswork.
— Peter Sander
Authors’ Acknowledgments
Many individuals and life experiences have taught me to recognize not just the cost or benefit but the value of something I might choose, be it a purchase, a place to live, or an investment. I’d especially like to thank my parents, Betty and Jerry Sander, for instilling this perspective from an early age. And no book can happen without the professional guidance and assistance of an editorial team, and I’d like to recognize and thank Stacy Kennedy for her overall supervision of this project and Tracy Brown Collins for her adroit editorial guidance throughout.
— Peter Sander
Publisher’s Acknowledgments
We’re proud of this book; please send us your comments through our Dummies online registration form located at www.dummies.com/register/.
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Acquisitions, Editorial, and Media Development
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Contents
Title
Introduction
How to Use This Book
What Is Assumed About You
How This Book Is Organized
Icons Used in This Book
Part I : The What and Why of Value Investing
Chapter 1: An Investor’s Guide to Value Investing
Definitions? No Two Are Alike
What Is Value Investing?
Value Investing Is Not...
Comparing the Value Investing Style to Others
The Value Investing Style
Are You a Value Investor?
Chapter 2: How Value Investors View the Markets — and Vice Versa
Markets and Market Performance
The Markets: How We Got Here
The Investing Climate — Changed Forever?
Chapter 3: The Value Investing Story
The Patriarch: Benjamin Graham
The Master: Warren Buffett
The Disciples
Part II : Fundamentals for Fundamentalists
Chapter 4: A Painless Course in Value Investing Math
Lesson 1: Time Value of Money
Lesson 2: The Amazing Power of Compounding
Lesson 3: The Amazing Rule of 72
Lesson 4: The Frugal Investor, or How Being Cheap Really Pays
Lesson 5: Opportunity Lost
Lesson 6: Discounting
Lesson 7: Be Wary of Large Numbers
Lesson 8: Inflation, Taxes, Interest Rates, and Risk
Chapter 5: A Guide to Value Investing Resources
What a Value Investor Looks For
Value Investing Tool Kits
Chapter 6: Statements of Fact Part 1: Understanding Financial Statements
Accounting Isn’t Just for Accountants
The State of Financial Statements
Financial Statement Anatomy
What the Value Investor Looks For
Chapter 7: Statements of Fact Part 2: The Balance Sheet
A Question of Balance
A Swift Kick in the Asset
Does the Company Owe Money?
And Now, Meet the Owners
Chapter 8: Statements of Fact Part 3: Earnings and Cash Flow Statements
The Importance of Earnings
Exploring the Earnings Statement
In and Out of Pocket: Statement of Cash Flows
Chapter 9: Games Companies Play: Irrational Exuberance in the Financial Statements
Financial Reporting in Perspective
The Rules — and Where They Come From
Accounting S-t-r-e-t-c-h
Pro Forma Performance
What Should a Value Investor Look For?
Chapter 10: On Your Ratio Dial: Using Ratios to Understand Financial Statements
Ratio-nal Analysis
What’s on the Ratio Dial
Part III : So You Wanna Buy a Business?
Chapter 11: Appraising a Business
Business Valuation vs. Stock Valuation
What Goes into Valuing a Business
Appraising Business Value
Chapter 12: Running the Numbers: Intrinsic Value
The Intrinsic Value of Intrinsic Value
Intrinsic Value Basics
Intrinsic Value Models
Getting Started: The Intrinsic Value Worksheet
The iStockResearch Model
The Ben Graham Model
Chapter 13: Running the Numbers: Strategic Financials
The Importance of ROE
ROE versus ROTC
The Strategic Value Chain
The Simpson Example
Profitability
Productivity
Capital Structure
Finally — A Sample
Chapter 14: Beyond the Numbers: Strategic Intangibles
Good to Great
Market Power
All About Management
Ownership
Walking the Streets
Checking Good to Great
Chapter 15: Warren’s Way
The Buffett Wisdom
Tenets, Anyone?
Chapter 16: Shopping for Value: Deciding When the Price Is Right
The Inside-Out Approach to Buying
All in the P/E Family
Making the Buy Decision
Part IV : Becoming a Value Investor
Chapter 17: Special Packages: Funds, REITs, and ETFs for Value Investors
Mutual Funds
Closed-Ended Funds
Real Estate Investment Trusts
Exchange Traded Funds
How Value Investors Use Investment Products
Chapter 18: Shopping for Value: A Practical Approach
The Thought Process Is What Counts
Recognizing Value Situations
Making the Value Judgment in Practice
It Ain’t Over ’til It’s Over
Part V : The Part of Tens
Chapter 19: Ten Signs of Value
Tangible: Steady or Increasing Return on Equity (ROE)
Tangible: Strong and Growing Profitability
Tangible: Improving Productivity
Tangible: Producer, Not Consumer, of Capital
Tangible: The Right Valuation Ratios
Intangible: A Franchise
Intangible: Price Control
Intangible: Market Leadership
Intangible: Candid Management
Intangible: Customer Care
Chapter 20: Ten Signs of Unvalue
Tangible: Deteriorating Margins
Tangible: Receivables or Inventory Growth Outpacing Sales
Tangible: Poor Earnings Quality
Tangible: Inconsistent Results
Tangible: Good Business, but Stock Is Too Expensive
Intangible: Acquisition Addiction
Intangible: On the Discount Rack
Intangible: Losing Market Share
Intangible: Can’t Control Cost Structure
Intangible: Management in Hiding
Chapter 21: Ten Habits of Highly Successful Value Investors
Do the Due Diligence
Think Independently and Trust Yourself
Ignore the Market
Always Think Long Term
Remember That You’re Buying a Business
Always Buy “On Sale”
Keep Emotion Out of It
Invest to Meet Goals, Not to Earn Bragging Rights
Swing Only at Good Pitches
Keep Your Antennae Up
: Further Reading
Introduction
Markets go up; markets go down. It doesn’t matter whether you measure it statistically or look at a chart. You can see it easily. We’ve seen more volatility during the past 10 years than ever before. And our hearts jump into our throats every time we hear about one of those 200-point sell-offs. Right?
You lived through the Asian market crisis of the late 1990s. You lived through the post-2000 dot-com bust. Heck, if you’re old enough, you lived through the famous October 19, 1987 “Black Monday” debacle. It’s all part of investing. Right?
Sure, like most other investors, you probably lost some money during these events — on paper, anyway. Sour markets have a way of putting a damper on everything. But do all stock prices drop? Especially in the long term? Hardly. Average stock investing performance, over the long haul, achieves roughly an 11 percent return per year.
Some investments do a lot better than that. And some will even take you through the down cycles with little to no heartache.
And what investments are those? They are investments in truly good businesses with enduring and growing value. Starbucks isn’t just about coffee; it continues to change the market for an informal business and pleasure “hangout” and is now shifting focus to overseas expansion. Procter & Gamble continues to dominate the grocery shelf. A lesser known used car retailer called CarMax threatens, with an excellent brand and business model, to dominate the used car space, though today its market share is less than 2 percent.
Bottom line: The best businesses that have the best brands, best assets, best business models, best management teams, and best business strategies continue to earn, earn, and earn some more. And if you, as an investor, (1) recognize the value and (2) buy them cheap, you’re setting yourself up for better returns than the market average. And that, as we’ll see, is a very, very good thing.
Which leads us to where this book is headed. Value Investing ForDummies, second edition, takes you on a journey back to the tried-and-true principles of valuing a stock as one would value a business. (After all, how can one disconnect the two, as a share of stock is a share of a business. Right?) When the price, or value, of a stock matches the value of a business, the value investor considers buying it. When the price of a stock is less than the value of the business, the value investor warms and may get excited about buying it. It may be a true buying opportunity. And when the price of the stock skyrockets beyond the value of the company, yes, the value investor sells it or avoids it altogether.
It’s good old-fashioned investing. Believe it or not, markets do undervalue businesses, and do it frequently. For a variety of reasons, markets are far from perfect in valuing companies. And furthermore, because there is no one secret or magic formula for valuing a business, the true value of a stock is a matter of difference of opinion anyway. All of which serves to make investing more fun — and profitable — for the prudent and diligent investor who sorts through available information to best understand a company’s value.
A value investor who applies the principles brought forth in this book is essentially betting with the house. The odds, especially in the long term, are in your favor. Value investing is an approach to investing, an investing discipline, a thought process; it is not a specific formula or set of technologies applied to investing. It is art and science. It is patience and discipline. Done right, it increases the odds but doesn’t guarantee victory. For you active traders, it’s a slower ride. But the value approach lets you share in the growth of the American (and world) economy, while also letting you sleep at night.
How to Use This Book
This book presents the principles and practices of value investing. As with all investing books, you probably shouldn’t follow this material to the letter, but rather incorporate it into your own personal investing style. Even if you don’t adopt most of the principles and techniques described here, your awareness of them will most likely make you a better investor.
This value investing reference visits tools that all but the most inexperienced investors have heard of: annual reports, income statements, balance sheets, P/E ratios, and the like. Value Investing For Dummies, second edition, uses these tools to create a complete, holistic investing approach. You’ll learn why annual reports and information contained therein are important, and how to use that information to improve your investing. And it’s hardly just annual reports. Other information sources, both online and offline, can greatly enhance your knowledge of a company’s prospects and your proficiency as a value investor.
What Is Assumed About You
Value Investing For Dummies, second edition, assumes some level of familiarity and experience with investments and investing. The book assumes you understand what stocks are and how markets work, and have already bought and sold some stocks. If you’re starting completely from scratch, you may want to refer to Eric Tyson’s Investing For Dummies or a similar introductory treatment of the investing world. Not that what’s presented here is that “hard” or scary, it will just flow more smoothly with a base level of knowledge.
How This Book Is Organized
Like all ForDummies books, this book is a reference, not a tutorial, which means that the topics covered are organized in self-contained chapters. So you don’t have to read the book from cover to cover if you don’t want to. Just pick out the topics that interest you from the Table of Contents or Index and go from there. What follows is a breakdown of what the book covers.
Part I: The What and Why of Value Investing
Part I explains what value investing is (and what it isn’t) to give a clear picture to the reader and provide a framework for the rest of the book. Value investing is put in context with a discussion of markets, market history, and overall performance. We explore the history of the value investing approach and the fantastic success of some who practice it, notably the master himself, Warren Buffett.
Part II: Fundamentals for Fundamentalists
Part II opens the value investor toolbox by explaining some basic investing math principles and how understanding that math can make you a better investor. Next is a discussion of key information and information sources for the value investor. Then comes the detail, with a tour of the financial statement landscape, including balance sheets, income, and cash flow statements. Ratios and ratio analysis are explored as a way to make more sense of the financials. Finally, you’ll get a few tips on how to detect hidden agendas that may lie in financial figures and statements.
Part III: So You Wanna Buy a Business?
Out of the frying pan and into the fire. Next come the “meat and potatoes” of how to assess or appraise the value of a company and relate that value to the stock price. Proven business value assessment methods including intrinsic value, discounted cash flow analysis, and the strategic profit formula are examined. Next, on the principle that investors shouldn’t live by numbers alone, is a discussion of strategic intangibles — so-called “soft” factors that serve as leading indicators for the ‘hard” numbers. To bring these tools and techniques together into a system, we’ll look at the example set by the master, Warren Buffett. With these principles in mind, the next step is to look at price, to see whether a company really is a good value for the price.
Part IV: Becoming a Value Investor
This part takes a practical look at investment products — mutual funds, closed ended funds, REITs, and exchange traded funds (ETFs) — and how the value investor may use these products. Then, the focus shifts to setting goals and developing your own value investing style. We examine different value investing themes and then suggest practical approaches to implementing the value investing thought process, not only for buying but also during ownership and, eventually, the selling decision. At the end of the day, it’s all about figuring out what works best for you.
Part V: The Part of Tens
For your use and enjoyment you’ll find some favorite top-ten lists in this section: Ten characteristics of a good business and stock value, ten indications of an overvalued business, and ten habits of “highly successful” value investors.
Icons Used in This Book
Throughout the book, bits of text are flagged with little pictures called icons. Here’s what they look like and what they mean:
Just as the name suggests: a piece of advice.
The dark side of a tip: advice on what to avoid or watch for.
Deeper explanation of a topic or idea. You can usually skip text flagged with this icon if you want to.
Not a must-read, but fun, relevant facts to enjoy as you drill through this book.
If you forget everything else you read, keep this information in mind.
Part I
The What and Why of Value Investing
In this part . . .
We hope to give a clear picture of what value investing is and isn’t and also provide a framework for the rest of the book. We put value investing in context with a discussion of markets, market history, and overall performance, with an emphasis on market nature –– key market behaviors and quirks that repeatedly, through history, provide opportunities for the value investor. We explore the history of the value investing approach and the fantastic success of some who practice it, notably the master himself, Warren Buffett.
Chapter 1
An Investor’s Guide to Value Investing
In This Chapter
Recognizing the value investing style — what it is and isn’t
Bottom-line value investing principles
Comparing value investing to other investing styles
Deciding if you’re a value investor
No doubt, if you’re reading Value Investing For Dummies, somewhere during your investing career you heard something about value investing. You heard about it from your retired next-door neighbor. You heard about it as “what Warren Buffett does.” You saw a mutual fund describe itself as a “value-oriented” fund.
You have a pretty good idea what the word “value” means in ordinary English. It’s not an altogether precise concept; the Random House Dictionary of the English Language defines it as the “relative worth, merit, or importance” of something. Okay, fine. But how does that apply to investing? What is value investing, anyway?
This chapter answers that question. The rest of this book gives you the background, tools, and thought processes to do it.
Definitions? No Two Are Alike
Perhaps you’ve asked around — to friends, experienced investors, investing professionals — for definitions of “value investing.” You probably got a lot of different answers. Those answers perhaps included phrases like “conservative,” “long-term oriented,” “the opposite of growth,” “the Buffett approach,” “buying stocks with a low P/E,” “buying stuff that’s cheap,” or “buying stocks that nobody wants.”
None of these is “it” entirely, but it turns out they are all part of it.
All, except the “opposite of growth,” that is — and we’ll get to that.
Value investing is an investing approach and style blending many principles of business and financial analysis to arrive at good investing decisions. This, too, is an imprecise definition, but it lays the groundwork for the more precise principles and style points that follow.
What Is Value Investing?
Toward a definition, here’s one you may have read in the first edition of Value Investing For Dummies. It still works:
Value investing is buying shares of a business as though you were buying the business itself. Value investors emphasize the intrinsic value of assets and current and future profits, and pay a price equal to or less than that value.
You’ll quickly note key phrases: “buying a business,” “intrinsic value,” and “pay a price equal to or less than that value.” These are explicit tenets of the value investing approach, and underlying them all is the notion of conscious appraisal — that is, the idea of a rigorous and deliberate attempt to measure business value.
You’ll also notice that “price” enters the appraisal, but not until the end. Value investors only go to the stock market to buy their shares of the business. Value investors don’t look at the market as an indicator of whether to invest.
With this definition of value investing as an appetizer, here’s a “main course” of value investing principles.
Buying a business
If you take nothing else away from reading this book, take away the thought process that investing in stocks is really (or should be) like buying a business.
That concept shouldn’t really be that hard to grasp — after all, when you buy shares, you are buying a portion of a business, albeit in most cases a small one. This isn’t to say you have to buy a larger share of the business to think of your investment as buying a business — this principle applies even if you’re buying a single share.
Put differently, whether it’s an espresso cart or 1,000 shares of Starbucks you want to buy, the purchase is analyzed the same way. Treat the investment as if you were buying the business — the whole business. By buying shares, you’re committing capital to that enterprise in exchange for an eventual healthy and appropriate return on that investment.
Now, some of you who got caught in the tech boom and bust may think you did exactly that. You followed a company and its story. The products were “killer apps” and everything the company did made headlines. Everybody wanted to own its products or work for the company. So you bought shares.
But did you look at business fundamentals? Intrinsic value of assets and future profit prospects? Did you understand their strategy and competitive advantages? Did you do your homework to assess whether the stock price was at or below your appraisal? Likely not. That’s the difference between value investing and most other forms of investing.
Making a conscious appraisal
If you were interested in buying a business for yourself and thought the corner hardware store looked attractive, how much would you be willing to pay for it? You would likely be influenced by the sale price of other hardware stores and by opinions shared by neighbors and other customers. But you would still center your attention on the intrinsic economic value — the worth and profit-generation potential — of that business, and a determination of whether that worth and profit justified the price, before you committed your hard-earned dough.
Value investors like to refer to this as an appraisal of the business. The business would be appraised just as one would appraise a piece of property or a prized antique. In fact, a business appraisal is deeper and more systematic than either of those two examples, as value is assigned to property or antiques mainly by looking at the market and seeing what other houses or vases of similar quality sold for. In the investing arena, there’s so much more to go on. There are real facts and figures, all publicly available, upon which the investor can base a true numbers appraisal, an appraisal of intrinsic value, not just the market price.
Appraising the value, relating the value to the price, and looking for good bargains captures the essence of the value approach.
Beyond investment analysis
You may be inclined to ask, “Isn’t value investing merely ‘souped up’ investment analysis?” The kind of analysis done by professional Wall Street analysts?
It’s a good question, and becoming a better one as the tech boom and its excesses fade into history. Analysts in those days were too focused on stock prices and the general “buzz” about an industry, and were often too influenced by their peers. Witness the hype about Amazon.com, which turned out to be far too optimistic (and indeed at the time of this writing, still is).
Basic investment analysis should start with an analysis of business fundamentals — the metrics and measures that define business performance, like profitability, productivity, and capital structure. But it needs to go further to be blended with the “story” to determine whether the fundamentals will hold up, or better yet, improve. The “boom years” investment analysis tended to overlook the fundamentals altogether, marching straight into the story. Some analysts today tend to focus too much on fundamentals, like return on equity (ROE) or “free cash flow,” without understanding the story.
The value investor gets good at understanding and blending both — the fundamentals, the story, and how the two work together to define a really great business.
Chapters 6–10 dig into the mechanics of financial statements and fundamentals, while Chapters 11–15 explore how financial and marketplace fundamentals work together to define “intrinsic” and “strategic” values of a business. At the end of the day, your appraisal will touch all of these bases.
Get used to this idea: Adopting the value investing approach means becoming your own investment analyst. You may read the work of others, but you’ll incorporate it into your own analysis and investing decision. As your own analyst, the pay can be good, but isn’t guaranteed — it’s clearly a “pay-for-performance” proposition. One thing for certain: You’ll never have to buy or dry clean a Brooks Brothers suit!
Ignoring the market
How can you spot the value investor at a cocktail party? Easy. He’s the only one talking about an actual company while all others stand around discussing the stock market.
The bird of a value-investing feather is easily spotted. Focusing on the company itself, not on the market is a consistent value investing attribute. As a general rule, value investors ignore the market and couldn’t care less what the Dow or NASDAQ do on a particular day. They tune out the brokers, advisers, commentators, chat-roomers, and friends (insofar as investment advice is concerned, anyway). They may, however, listen to folks in the industry, customers, or people who know a lot about competitors.
Value investors have a long-term focus. And if a value investor has done his or her homework right, what the market does to his stocks on a daily basis is irrelevant. If the company has value but the stock went down on Tuesday, a value investor feels that it’s probably a result of the market misreading the company’s value.
Now, to be sure, external factors can affect stock prices. Interest rates, in particular, can affect not only stock prices but also the true intrinsic value of companies, as the cost of capital rises and falls and the value of alternative investments increases (there’s more in Chapters 3 and 12). So while it makes sense to pay some attention to the markets, especially in the long term, daily fluctuations, particularly when they are just that, should be ignored. The value investor can wait anywhere from a few years to forever for her investments to mature. The value investor looks for a good price with respect to value, but doesn’t try to time the market. If the value is there and the price is right, it will probably be right tomorrow, too.
Some sage advice from Warren Buffett: “For some reason, people take their cues from price action rather than from values. What doesn’t work is when you start doing things that you don’t understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it’s going up.”
Value Investing Is Not...
Following the same thread of logic that holds that “we all learn best from our mistakes,” sometimes the best way to define what something is is to define what it isn’t. Or at least, to show why it isn’t constrained to a limiting attribute like “value investing is long-term investing.”
One at a time...
Not just conservative
Most people equate the concept of “value” investing with “conservative” investing. Conservative investors focus on minimizing risk, and in many cases, maximizing short-term cash returns from investments.
Fixed income investments — such as bonds and money market funds and stocks in placid sectors like utilities and insurance companies — meet the “conservative” criteria, and there is nothing wrong with these investments. Indeed, most, but not all fit “value” criteria as well — strong intrinsic value, steady, predictable returns — at a reasonable price.
But while most conservative investments are value investments, not all value investments are conservative. It is possible to view a company like Starbucks, with incredibly strong brand features, strategic position, and growth potential, especially ten years ago, as a value investment. A conservative investment, no, but a value investment, quite possibly yes.
Not just long term
Most value investments are long term. In fact, the Buffettonian view is to “hold forever” and look for businesses that you would want to hold forever. That’s part of what makes them a good value.
But not all long-term investments are good values, and not all value investments are long term. Indeed, as business cycles shorten today, what is excellent today may look like a flash in the pan as technologies used in business and marketplace acceptance change.
Buffett deals with this problem by simply avoiding technology makers and heavily technology driven companies, for example, because (1) technology changes and (2) he doesn’t understand technology in the first place. But even stable businesses see their products change and change ever more quickly. You once could buy only one “flavor” of Tide detergent, but now there are dozens, and they change all the time. And it isn’t just all powder — there are liquids, concentrated liquids — you get the idea.
So when buying a business, it’s good to look long term, but you must also realize that businesses and their markets change, and you should always be prepared to sell a business if assumptions change. That said, most value investments — if they are truly value investments — should be good to hold onto for more than a year, which is the IRS definition of “long term.”
Not just low P/E
Oil companies, banks, food producers, and steel companies all have had P/E ratios (price-to-earnings) below market averages. But does that mean they are good values? Sometimes, but not always. Bethlehem Steel or — ahem — Enron all traded at one time or another with low P/Es. But the earnings, and the business itself, turned out not to be sustainable.
So while low P/E can be part of the investing equation, especially when deciding when the stock price is right, it is far from the whole story.
Not the “opposite of growth”
“Stock ABC is a growth stock, and stock XYZ is a value stock.” You hear that all the time, and you’ll also hear it about mutual funds, which have been neatly divvied up by stock and fund information portal Morningstar (www.morningstar.com) into neat little boxes tagged as “growth,” “value,” and “blend.”
So value stocks aren’t supposed to grow? Well, some, like your local electric utility, may prosper just fine on the business they have, and may pay you handsome returns in the form of dividends. But for most companies, growth is an integral part of the value of the business — it creates the return you desire as an investor.
So this treatment of value investing places growth in the center of the “value” stage. It is the potential for growth that defines Starbucks and its brethren as good values — the current assets and perhaps even current business levels alone don’t justify the price. Indeed, this is what separates early value investing, as practiced and preached by patriarch Ben Graham, from the more recent views practiced by Buffett and many of his current disciples: Growth creates value. More on this in Chapter 3 and throughout the book.
Cheap is a relative term
Above all, value investors seek to buy businesses at or below their appraised value. Why? Not just because they like to get a good deal — it’s to provide a margin of safety.
Because any business appraisal is imprecise at best, the value investor likes to give a cushion for error, a cushion just in case things don’t turn out exactly as assessed.
So does that mean that a value investor always buys a stock below its highest price? Usually, but not always. Does a value investor “bottom fish” for the lowest 52-week price? Usually not. Why? Because it’s all about price relative to value. A stock at a 52-week low may have serious flaws in its business or marketplace acceptance.
And value investors have been known to buy stocks at 52-week highs — if (and only if) even that price understated their value appraisal. Doesn’t happen often, but knowing that it does happens reinforces the true value concept.
Evaluating your values
Value can be defined in many, many ways. Kind of like pleasure, the term probably means something different to each one of us. Investors of all feathers attach different meanings — a day trader can look at a small uptick and call a stock a value at a current price. Even among value investors, the definition of the word may vary. Some additional perspective may be in order. Timothy Vick, in his book Wall Street on Sale (McGraw-Hill, 1999) provides a few definitions of value that are recognized by U.S. civil law:
Fair market value is whatever someone will be willing to pay for a similar asset — a.k.a. market value.
Book value is a company’s net worth on an accounting basis, which may differ from true financial value because of accounting rules, timing, and so on.
Liquidation value (which is very subjective and hard to predict) is what a company would be worth if all the assets were sold.
Intrinsic value is “what an appraiser could conclude a business is worth after undertaking an analysis of the company’s financial position,” based on assets, income, and potential growth. The value investor looks to establish intrinsic value. Only in some situations will the value investor take book or liquidation value into account.
Comparing the Value Investing Style to Others
Value investing is more than just a set of rules or guiding principles; it is an investing style. It is an approach; a thought process; a “school” of investing; a way of investing life that governs investing behavior for at least a portion of an investor’s portfolio. Just like with the definition of value investing itself, it helps to contrast the value investing style with other popular styles you may have come across.
Throughout market history, much has been made of the different approaches to investing. There are fundamental and technical analysis, momentum investing, trading, day trading, growth investing, income investing, and speculating. And there’s story or concept investing, where the investor goes with whatever fad or technology is popular or sounds popular, without regard to intrinsic value or price. Add to these the academic treatments of security valuation and portfolio theory that may make it as far as institutional trading desks but seldom find their way to individual’s bookshelves.
In words that Abraham Lincoln may have used, all styles make money some of the time, but no one style makes money all of the time. Each style suggests a different approach to markets, the valuation of companies, and the valuation of stocks.
Table 1-1 summarizes the differences among various investing styles.
The Value Investing Style
We’ve stated it before: Value investing is a style of investing. It’s an approach to investing. You, as an investor, will adopt some of the principles presented here, but not all of them. You will develop a style and system that works for you, and the knowledge available in the rest of this book will contribute to your style.
No magic formulas
Some people buy and read investing books looking for a magic formula that guarantees success. Buy when a stock crosses its 50-day moving average and you’ll profit every time, or buy when the PEG (covered in Chapter 16) is less than 1.0.
Value investing isn’t quite that simple. There are so many elements and nuances that go into a company’s business that you can’t know them all, let alone figure out how to weigh them in your model. So rather than a recipe for success, you will instead have a list of ingredients that should be in every dish. But the art of cooking it up into a suitable value investment is up to you.
Like all other investing approaches, value investing is both art and science. It is more scientific and methodical than some approaches, but it is by no means completely formulaic. Why, if it were, everyone would use the same formula, and there would be no reason for a market! Stock prices would simply equal formulaic value. Wouldn’t that be boring?
Always do due diligence
It can’t be repeated enough: The value investor must do the numbers and work to understand a company’s value. Although, as explained in Chapter 5, there are information sources and services that do some of the number crunching, you’re not relieved of the duty of looking at, interpreting, and understanding the results. Diligent value investors review the facts and don’t act until they’re confident in their understanding of the company, its value, and the relation between value and price.
Nipping closely at the heels of diligence is discipline. The value investor does the work, applies sound judgment, and patiently waits for the right price. That is what separates the masters like Buffett from the rest.
Investing is no more than the allocation of capital for use by an enterprise with the idea of achieving a suitable return. He who allocates capital best wins!
A quest for consistency
While value investors have varying approaches to risk, some willing to accept greater risk for greater rewards, almost all like a degree of consistency in returns, profitability, growth, asset value, management effectiveness, customer base, supply chain, and most other aspects of the business. It’s the same consistency you’d strive for if you bought that espresso cart or hardware store yourself.
Before agreeing to buy that hardware store, you’d probably want to know that the customer base is stable and that income flows are steady or at least predictable. If that’s not the case, you would need to have a certain amount of additional capital to absorb the variations. Perhaps you’d need more for more advertising or promotion to bolster the customer base.
In short, there would be an uncertainty in the business, which, from the owner’s point of view, translates to risk. The presence of risk requires additional capital and causes greater doubt about the success of the investment for you or any other investors in the business. As a result, the potential return required to accept this risk and make you, the investor, look the other way is greater.
The value investor looks for consistency in an attempt to minimize risk and provide a margin of safety for his or her investment. This is not to say the value investor won’t invest in a risky enterprise; it’s just to say that the price paid for earnings potential must correctly reflect the risk. Consistency need not be absolute, but predictable performance is important.
Focus on intangibles
As you’ll see in detail especially in Chapter 14, today’s value investors are as intently focused on business intangibles, like brand and customer loyalty, as on the “hard” financials. It’s all about looking at what’s behind the numbers, and moreover, what will create tangible value in the future.
So a look at the market or markets in which the company operates is important. Looking at products, market position, brand, public perception, customers and customer perception, supply chain, leadership, opinions, and a host of others factors is important.
Provide a margin of safety
We mentioned the idea of buying a company at a bargain price to achieve a margin of safety; that is, to provide a buffer if business events don’t turn out exactly as predicted (and they won’t). The value investing style calls for building in margins of safety by buying at a reasonable price. The style also suggests finding margins of safety within the business itself, for instance, so-called “moats” or competitive advantages that differentiate the business from its competitors. Finally, a large cash hoard or the absence of debt offers a financial margin of safety.
It’s not about diversification
You probably have heard on every talk show or read in every investing magazine that the key to investing success is to diversify. Diversification provides safety in numbers and avoids the eggs-in-one-basket syndrome, so it protects the value of a portfolio.
Well, yes, there’s some truth to that. But the masters of value investing have shown that diversification only serves to dilute returns. If you’re doing the value investing thing right, you are picking the right companies at the right price, so there’s no need to provide this extra insurance. In fact, over-diversification only serves to dilute returns. That said, perhaps diversification isn’t a bad idea until you prove yourself a good value investor. The point is that, somewhat counter to the conservative image, diversification per se is not a value investing technique. More about this is found in Chapter 4.
A blended approach
If you decide to take up the value investing approach, know that it doesn’t have to be an all-or-nothing commitment. The value investing approach should serve you well if you use it for, say, 80 percent or 90 percent of your stock portfolio. Be diligent, select the stocks, and sock them away for the long term as a portfolio foundation. But that shouldn’t exclude the occasional possibility of trying to enhance portfolio returns by using more aggressive short-term tactics, like buying call options.
These tactics work faster than traditional value investments, which may require years for the fruits to ripen. Of course, this doesn’t mean taking unnecessary or silly risks; rather, it means that sometimes investments can perform well based on something other than long-term intrinsic value. It doesn’t hurt to try to capitalize on that, so long as you understand the risks and are willing to face losses. In fact, it’s best to think of a short-term trading opportunity as simply a very short-term value investment — a stock, for instance, is very temporarily on sale relative to its true value.
Likewise, it’s perfectly okay to put capital away for short-term fixed returns. You don’t have to work hard on “due diligence” for all parts of your portfolio at the same time.
A solid base in bonds, money market funds, or similar investments will produce returns and allow you to focus your energy on the parts of your portfolio you do want to manage more actively.
You don’t have to use the value investing approach for all your investments. Depending on your goals, it’s okay to mix investing styles.
Are You a Value Investor?
By now, you’ve probably asked yourself the questions, “Am I patient enough?” “Do I have what takes?” “Can I do the numbers stuff?” “I’m not sure I was cut out to be an entrepreneur — how to I appraise a business?” Here are seven character traits found in most value investors:
Bargain hunter: Do you check the price of the hotel across the street before you check into your chosen hotel? Do you study detailed automobile specifications and prices before you buy? Do you look at different boxes of detergent to see how much better the deal is on the 67-ounce size versus the 43-ounce size? You have a key trait of a value investor, although we continue to be surprised at otherwise frugal folks who are willing to throw investment dollars at almost anything.
Do it yourselfer: Value investors want to check the numbers themselves and build their own assessments. By doing so, they develop a better understanding of the company and its fundamentals.
Like margins of safety: People who actually slow down when it rains are more likely to be better value investors.
Long-term focus: Value investors would rather make a lot of money slowly than a little flashy money in one day. Sort of like going for marriage instead of one-night stands.
Business, not price oriented: The value investor focuses on the underlying business, not the price or superficial image. They look under the hood instead of at the trim. Value investing is sometimes called inside-out investing.
Numbers oriented: Not advanced mathematics, mind you, but you can’t get completely away from the numbers. Value investors are concerned about company business fundamentals and performance. For those who don’t like numbers, fortunately there are software packages that do some of the computation and preparation for you. And there are screeners to semi-automate company selection. Find out more in Chapter 5.
Contrarian: Value investors are not crowd followers! Value investors stay away from what’s exciting and hip quite purposefully. By definition, popular stocks aren’t normally bargains.
Value investors like to make lists of selection criteria and then choose companies that match the greatest number of them. You can do the same with this list. To be a good value investor, you certainly don’t need to excel in every trait! But you’ll find that five or six out of the seven listed here would be a big help.
Chapter 2
How Value Investors View the Markets — and Vice Versa
In This Chapter
Reviewing markets and market performance
Understanding how we got to where we are — a short market history
Looking at how today’s investing climate affects value investing
Volatility. The “V” word. You hear about it all the time. The market is on “cruise control,” and then all of a sudden, some little thing unforeseen happens to stir things up. Subprime loan defaults. Oil prices. The dot-com bubble burst. A war.
Yet, the markets have run mostly up and to the right for 25-plus years — since August 1982, in fact. The S&P 500 index — today’s most widely accepted index of the broader stock market — was hovering at about 100. In mid-2007; it reached a new all-time high of 1,555.90.
But along the way, we’ve had our bumps. Some five trillion in investment value or “market cap” wiped out in the 2000–2001 bear market. That steadily rising S&P 500 got “trucked” from its 2000 peak in the 1,500s all the way back to 775 in October 2002. Was that a big deal? You bet — for all of us.
The boom years of the late 1990s and the early part of the year 2000 signified an important change and an important turning point in the history of investing. Clearly, investing, investors, and investment practices at that time had moved away from analysis of value and the business fundamentals that support it. As the percentage of stock-owning households moved from the teens in the early 1970s to 30 percent in the 1980s to beyond 50 percent in 2001, a growing portion of the investing public knew little about reading financial statements — or perhaps even where to find one!
People bought stocks based on stories they heard from colleagues at the office, friends at cocktail parties, and neighbors over the backyard fence. And the retail brokerage industry got into the game, too, offering investment analysis that seemingly supported almost anything. Add to that the proliferation of online brokerages and the reinvention of do-it-yourself investing as online trading and we got a frothy investment mix driven by people who didn’t really know what they were doing.
Since then, however, value investing has caught on, and we’ve seen a dramatic return to investing based on fundamentals — so much so that many of the so-called “value” stocks actually became overvalued.
Add to that the dramatic shift in retirement savings from defined benefit pension plans to self-directed investment accounts — led by 401(k)s — and you have a far greater emphasis placed on long-term, fundamentals-based investing. That said, there will always be short-term “players” out there. . . .
The good news is that value investing has become more popular, so there’s more information and commentary out there to help the value investor. The bad news is that — well — value investing has become more popular — so it’s harder to find good values.
This chapter doesn’t dwell on the details of the story, but instead furnishes a contextual canvas onto which we can paint the value investing picture.
Markets and Market Performance
The story of markets and market performance over the past decade could fill many books (and has). This book doesn’t go that far, and won’t belabor the different markets, stock investing details like how trades are executed, or the myriad performance indicators. There are plenty of other places to pick up this information. But, more to the point: Value investors really don’t care.
Now that’s a bold statement. Do value investors have an attitude problem?
Nope. The point is that value investors aren’t that concerned about markets, trading processes, and trading behavior. The market is simply a place to buy a portion of a business — and perhaps not sell it for a long, long time. Value investors care little about whether an order is executed on the bid or ask price, nor do they care what regional market, ECN, or execution system was used. The transaction is an investment, a long-term investment. The market simply provides a place to acquire the investment. So the NYSE (New York Stock Exchange) or NASDAQ, market or limit order, SOES or SuperMontage, and other jargon from the world of active trading really don’t matter.
So in a departure from most investing books, we don’t talk much about markets. And if you’re really a value investor (or want to become one), you yourself don’t care about markets . . . except when they undervalue businesses.
Despite the academic rumblings of the “efficient market theory” (which holds that with good information and a sufficient number of players, markets will find the right price for a business), markets aren’t perfect. There are always bargains. Stocks may be undervalued because of lack of knowledge or lack of visibility, or perhaps they’re part of a group that’s out of favor altogether. These stocks are selling for less than may be indicated by the value of the business or the potentialof the business. So in this sense, value investors love the markets. The markets, through their imperfections, provide value investors their opportunity. As Warren Buffett says, if markets were perfect, he’d be “standing on the corner holding a tin cup.”
The Markets: How We Got Here
A stock market represents the sum total of the public’s perception of the business value of the companies trading in that market. True business value, which we explore in depth in this book, is the sum total of productive assets and, in particular, what those assets produce in the form of current and future earnings. As long as companies produce more, it makes sense that their values rise. And as long as the public perception matches true value, the stock value rises in lockstep.
You can and should expect, in aggregate, that the total value of all businesses would rise roughly in line with the increase in the size of the economy, as represented by gross domestic product (GDP). This is true, and it can be argued that business value grows further through increases in productivity. The value of market-traded businesses could rise still more if the businesses grew their share of the total economy — as Borders Group and Barnes and Noble have grown their share of the total bookselling business.
If you look closely at long-term stockmarket growth (by most measures of return, 10–11 percent annually) you see how the long-term GDP growth of 3 to 5 percent, productivity growth of 1 to 2 percent, and long-term inflation in the 3 to 6 percent range, added together, provide an explanation for the long-term market growth rate. In the short term, depending on the value of alternative investments, such as bonds, real estate, and so on, market value may actually rise faster or slower than business value. And inflation also tampers with market valuations. So can markets grow at 20 percent per year? Not for long.
It isn’t impossible for the markets to rise 20 percent in a given year or two, but such growth year after year is hard to fathom if the economy at large is growing at only 3 to 5 percent annually. But for a particular stock? Sure it’s possible. If the company is building a new business or is taking market share from existing businesses, 20 percent growth can be quite realistic. But forever? Doubtful. Some call this “reversion to the mean” — sooner or later, gravitational forces will take hold and a company will cease to grow at above-average rates. As an investor, you must realistically appraise when this will happen.
They say history predicts the future, so let’s take a short tour of the past six decades of stock market history, with special focus on lessons for value investors.
The “Good Old Days” — The 1950s and ’60s
Time was, you simply bought the market. You plunked down hard-earned money to invest in the American Way, believing it the right and most economically progressive way on the planet.
You bought for the long term. You owned General Motors, General Mills, RCA, and, if a little more adventurous, IBM or Xerox. The stock certificates sat in your safety deposit box and you most likely called your broker only if you had accumulated a little more money to invest, or if some was needed for a major purchase. A few government bonds or savings bonds may have sat alongside the stock certificates, purchased as much out of patriotic duty as for safety or investment return. Maybe you purchased a bank or S&L CD with an eye for safety, but also for the kitchen appliance “premium.”
You checked the paper at most weekly. At that time, many major newspapers didn’t have stock tables because only a small slice of the population had individual investments. You watched the Dow Industrials, Rails, Utilities, and 65 Stocks nightly on the Huntley-Brinkley Report. You cared more about the averages than your individual stocks, because the market was your stocks. You got excited when General Motors reported record sales and earnings, although you probably didn’t think too much about what that meant or whether it would continue. You probably bought stock in companies you worked for, and bought the company’s products out of a sense of duty to support your business. Your investments grew with the economy. There was little to worry about — and little for you to do.
Political Ties and International Dependence — The 1970s
On May 1, 1975, high fixed brokerage commissions became a thing of the past. A more competitive environment evolved with more, better, and cheaper services for individual investors. Lower commissions enabled more investors to trade in and out of stocks more frequently without worrying about high fixed commission costs. Markets became dramatically more liquid, with more investors and traders making more trades, and shifts between stock sectors, as well as in and out of the market, became much more feasible.
In the 1970s, investors and investment professionals alike started to realize that investments weren’t bound to follow the economy as a whole, that certain sectors and industries were bound to do better than others. Cyclical companies and companies overly dependent on cheap, abundant resources — such as foreign oil — were no longer the best bets. It was certainly the beginning of a more complex, dynamic investing climate with an ever-expanding list of factors that influenced investing performance. The advent of NASDAQ and deregulated commissions made “main street,” “do-it-yourself” investing really feasible for the first time.
But aside from annual reports and other company releases, there was little information for a value-oriented investor to use. Some individual investors began to speculate in rapidly rising resource and technology companies, but most continued to buy name-brand, blue-chip U.S. stocks. Unfortunately, some of these companies took big hits from resource supply shocks and the economic fallout that followed. Large conglomerates, the 1960s’ answer to productivity gains and stability, fell apart in the 1970s. Many investors became skeptical of big corporations for the first time.
