It's easy to keep your head when you follow a value investing strategy.
When times are hard and markets as jittery as they've been of late, it's worth remembering what real value is all about.
There are various definitions and theories about value investing, but these can be simplified. To my mind, true value lies in oversold stock with solid assets that can be chased down with confidence when the share price allows.
Rocket science it's not. But buying more shares in a company whose valuation is plummeting will take courage and confidence in your knowledge of the assets of the company concerned; easier said than done.
For momentum traders, this is counter-intuitive. So be it. This is value investing and it takes patience to come good. There's certainly no room for stop-losses -- nor for short termism. In fact, the exact opposite approach is required.
The cheaper the shares, the lower the market cap, and the better the investment. It may, therefore, be necessary to buy more on the falls. Such a "back to basics" approach won't always come good. But it will come good many more times than it doesn't.
This may sound simplistic, but even the dourest of value hunters can depart from their magnetic north when times are good and making money is easy as it has been over the past year. This is a mistake. But it's also a comfort to have a beacon in troubled times.
Consider the value investor's likely timeline and dealings over the past couple of topsy-turvy years:
- Late 2007, most of 2008: Generally; not much value to be had.
- Late 2008: The tide recedes rapidly leaving many value situations exposed. Value hunters buy, but see their purchases decline further.
- Early 2009: Ditto. Time to dig in and buy more.
- Autumn 2009: Many value situations have now been realised; time to sell where this is the case.
- Now: There is some value to be found as the tide recedes again.
The end result is one of excellent performance. This is all very easy in hindsight, but following a value-based investing strategy has yielded such a result as I can testify from personal experience.
Success is dangerous
The problem is one of a lack of discipline. When there's not much underlying value to be had; the kind you can safely dig down at, the temptation is to lend too much weight to the other variables such as price-to-earnings, and yields, which -- though very important -- can disappear overnight.
Success breeds a dangerous desire for repetition, even when there is no deep value to be had. This is not the case with solid, good quality (and preferably appreciating…) assets whose value can be safely chased down when the share price falls.
To do this, though, you need to have a good knowledge of the assets. There are many companies around whose price to tangible book value looks temptingly low. But how much is their freehold property worth in today's market. When was it last valued? How quickly is machinery likely to deteriorate and what's its realistic re-sale value? What's the value of the stock in a fire sale? How much cash is there and how quickly is cash being burned up? How likely is it that debtors will pay up?
It's very difficult to get a good handle on all this and it's generally easier the smaller the company is. This is no investing nirvana; there'll always be mistakes, dishonesty and bad management. But you will get it right most of the time -- and you can't ask for as lot more than that.
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