What is Value Investing?

Q:What is Value Investing?

A: Value – To my mind is a correct strategy – find companies that exhibit value in whatever characteristic(s) you like and buy them cheap. For some this is PER, some cash flow, others Tangible book value and of course for income seekers there’s the High Yield variety.

However, don’t forget that the valuation of any asset is a relative concept. First of all one cannot value an asset by itself as the valuation of an asset is constantly changing and may depend on external factors. For instance suppose I was offered property for £100,000 and it had an annual rental toll of £10,000 then that property is offering me a 10% rental yield. In isolation this doesn’t tell you much. If bank deposits rates are also 10% then the attraction of that property as an investment is not so great after all. But what if interest rates decline to 5%? Well suddenly the rent on that property is more attractive. Of course, in reality, any such decline in interest rates would (in theory at least) start to push up property prices – investors would seek out such properties until the prices rose sufficiently to lower the rental yield to near interest rates of 5%. The corollary, of course, is that rising interest rates act as a depressant on asset values. So although understanding valuation is important but this taking into consideration the relative valuation.

So while accepting the valuation of the aggregate market as it is you should concentrate on buying a portfolio of stocks that offer, in aggregate, better value than the overall market.

Q:But why do you believe Value can work?

A: This is a key question and oddly enough someone on a bulletin board recently made me think a bit more about it. First, I think we have to consider ‘What is the market?’ To me ‘the market’ is ‘moment in time’ supply and demand. I think it’s the ‘moment in time’ bit term bit that’s key – anyone who’s been watching level 2 for a bit can surely testify to this.

I’ve seen share prices jump 5-10% on bid rumours and indeed often in the auctions you can get bargains where there’s a big seller or buyer in the market at that ‘moment in time’. Indeed, I’ve made a fair of money out of these situations – it ain’t rocket science just pure price driven by demand.

Remembering that the general idea for stock pricing at any given time (especially for a Market Maker driven stock) is to meet demand and offer supply. I believe it is that simple. So for one taking a longer term view with no need to be so short term about it value has huge strengths. So to sum up the principle I think ‘the market’ can get it wrong and often does.

Q:I’m looking to trade companies that are undervalued but fundamentally sound? How do I track such companies?

A: The first thing to do before evaluating a company’s technicals is to make sure that the global markets are moving in the correct direction. Which sectors are outperfoming? Which industries are constantly in the news? Which industries are likely to benefit most as the economy moves further into recovery mode? Knowing the answers to these questions will give you a starting point. Once you have established this you need to be able to digest a company’s technicals i.e. interpreting such terms as Price/Earnings, Profit Margin, Quarterly Revenue Growth (yoy), Total Cash, Total Debt and Operating Cash Flow as well as Levered Free Cash Flow. This representation of financial information will provide you with an insight of a company’s balance sheet.

In some cases you will find cases of companies that appear to be fundamentally sound but whose share price is still underperforming; it could be that you’re missing something from the balance sheet or the company has simply not attracted institutional interest. In such cases understanding financial information, such as a stock’s Beta, 52-week High/Low, Moving Averages, Average Volume Traded, Shares Outstanding and in Float and Crest Loan Data (which indicates shorting interest) can go a long way. Personally I prefer companies with healthy balance sheets that have experienced consistent year-over-year quarterly growth, lots of operational cash flow and healthy doses of cash on hand. Volume information is also important as weak volume implies wild swings in volatility.