A new book on value investing might help you become richer.
"Think of the search for value stocks like grocery shopping for the highest quality goods at the best possible price."
The above quote comes from an interesting new book -- The Little Book Of Value Investing by Christopher Browne. I think it's a fine introduction to the topic for value novices, and even more experienced value hunters may find it interesting.
Early in the book, there's a nice summary of the views of Benjamin Graham, the father of value investing. Browne puts particular emphasis on Graham's margin of safety. In other words, value investors should work out a company's intrinsic value, and then only buy shares in the company if its market value is significantly lower than the intrinsic value, giving the buyer a margin of safety.
Of course, finding clearly undervalued shares can be hard, especially when stock markets are buoyant. One place to look for bargains is a list of companies whose share price has just hit a low for the year or even five or ten years. Browne likens such a list to "a supermarket flyer with a list of shares on sale."
He's not suggesting that all the shares on the list will be worth buying; just that you may be able to find some attractively priced winners amidst the dross. When Browne evaluates companies on the list, he checks the balance sheet first. He's particularly keen to make sure the business doesn't carry too much debt. In his view, high levels of debt increase risk:
"A strong balance sheet is a good indicator of company's stamina, its ability to survive when the going gets tough."
Then he looks at profits. He likes to see a nice, steady gross profit margin and low operating expenses. He particularly dislikes rising operating expenses.
Here are some of Browne's other favourite questions when he's looking at a company:
- Can the company easily raise its prices? That's been relatively easy over the years for a tobacco company such as Altria
(NYSE: MO)
, formerly Philip Morris, but is much harder for PC company Dell
(NASDAQ: Dell)
, which operates in a market where prices keep on falling.
- Can the business increase its sales without reducing prices? The big US car manufacturers increased sales in 2005, but achieved this by cutting prices; that's not normally a recipe for long-term success.
- Have there been any takeovers or mergers in the sector? Does any recent deal suggest that the market is undervaluing the company?
- What are the plans of the company's rivals?
There are also some nice stats in the appendix which back up Browne's value thesis. He cites one study by Fama and French which looked at a large database of US nonfinancial stocks between 1963 and 1990. Apparently the lowest price-to-book value shares returned almost three times as much as the highest over the 27 year period.
Sounds familiar?
Much of the above won't be news to many Fools, especially if they've followed the progress of our Foolish valuemeister, Stephen Bland. If you'd like to find out more about value investing, take a look at our value page, and here's a list of Stephen's latest value articles
As for me, I've always been more of a growth investor and that will probably remain my principal approach. I certainly think there are some attractively priced growth shares out there. But I also know that I need to think more about value and, who knows, maybe I can find one of those golden companies that combine the best of both worlds.
> Pre-order this title from the Fool Bookshop (publication date: 18 October)
