Value Investing 01 (May 08 - Dec 08)

[winston]

[quote="millionairemind] machiam funny... if it takes 15 yrs.. Y don't you just not buy now and come back later??? [/quote]

How did these guys end up on Bloomberg or CNBC ? And they say it without blinking their eye. And they are so convinced of their position...

BTW, "machiam" is spelt "macam"

[millionairemind]

I stand corrected..

Tks W..

[Cheng]

hi cheng : thank you for the education....

Margin of Safety is to ensure that given the possible setbacks of the company the price will not drop too much below your purchase price. If the fair value of the business is 100, not very good to buy at 90, but should instead aim for 50-60 below.

in your example above, how would one know that the fair value of the business is 100? what method does one employ to determine such a "fair" value? knowing this is important, since the safety margin is derived from this.

again, i look forward to being enlightened...

thanks and best regards...

Kenny,

This is the toughest part, fair value, intrinsic value or whatever, it is just an estimate.

And if value investors get it wrong, gotta pay huge price for it. Have to switch quickly.

Recently Warren Buffett reduced his holdings on Bank of America and bought energy. See how he allocates capital quickly. In my opinion, most value investors miss this lesson. Anyone who copied him on buying BOC wouldn't know when he is going to sell, he delays his regulatory fillings somehow.

http://money.cnn.com/2008/11/14/news/companies/berkshire_conoco.ap/index.htm?section=money_latest

[kennynah]

hi cheng.... thank you...i hope we all realize after this discussion....there is no such thing as fair value... it is a figment of imagination...a subjective evaluation at best....

nonetheless...i appreciate your indulgence

[winston]

The Five Keys to Value Investing Profits By Keith Fitz-Gerald

Value funds have long been viewed as conservative investments. So why are they down an average of 42% during the past 12 months, and what’s wrong with them?

No question, such numbers are scary, especially for large-cap value fund investors who have experienced that 42% drop. And the fact that some of the biggest names in value investing have taken such big beatings has to be especially disconcerting for investors who already have had their confidence badly shaken and their portfolios eviscerated.

Bill Miller’s once-vaunted Legg Mason Value Trust fund (LMVTX) has dropped 62%. Meanwhile, Marty Whitman’s Third Avenue Value Fund (TAVFX) is down 50%. Even the Dodge & Cox Stock Fund (DODGX) fund has tumbled 49% year to date.

For many investors who viewed value funds as comparatively “safe,” low-risk investments, this has to feel like a betrayal. And that’s understandable, given that history has repeatedly shown the value discipline to be one of the strongest, most stable investment strategies available for navigating a bear market.

What’s different this time?

Some managers – like Legg Mason’s Miller, as well as the Dodge & Cox team, for example – simply underestimated the depth and severity of the challenges facing their investments. Adding insult to injury, they concentrated their investments in a relatively small number of core holdings they thought they “knew.” During good times, this concentration strategy can dramatically boost returns when stellar companies that had been trading at deep discounts subsequently rebound. But now, when times are tough, as is readily apparent, stockpiling money in one or two holdings like Lehman Bros. Holdings Inc. (OTC: LEHMQ) or Freddie Mac (FRE) can be devastating.

Others, like Whitman – a gentleman who is often regarded as the “Dean of Value Investing” – simply don’t sell all that often, preferring to ride out market gyrations, which they view as a mere nuisance. So their performance is likely to suffer in line with the markets. But that’s not necessarily a bad thing. In fact, Whitman, who is notorious for looking beyond what the public markets do, doesn’t care that prices have fallen so low. He believes that undervalued companies will be taken over, liquidated or refinanced which, as he pointed out in an interview with Brian Zen last year, is “where you make your money.”

While such strategies put value players on the losing side of the investment ledger for now, it will be a different ballgame when the markets turn, as they eventually will.

In fact, when we emerge from the other side of the current financial crisis – which we will, and probably sooner than everybody realizes – the deep-value choices available today will be some of the highest-performing investments for decades to come.

And for all the right reasons: Many of the underlying companies are still expecting solid business growth, diversified revenue streams and a clear path to higher earnings.

That means that one of the smartest moves a savvy investor can make today is to stick with the value-investing discipline. The historical record suggests that the best choices continue to be those companies with low or no debt, a high proportion of international revenue, and a history of solid dividend growth that pays us cold, hard cash for the ownership risks we take.

That is why there is nothing “wrong” with making value investing a key component of your investment strategy. Especially now.

As for the notion that “value” investing is broken, we don’t buy into that. Studies show that investing styles come and go. For instance, indexing might hold sway for awhile, until it gives way to a total-return strategy. Then the momentum players hold the majority. And so on.

What’s important to understand, however, is that styles don’t work all the time; they work over time, which is why it is more important than ever to maintain a laser-like focus when the going gets tough. The following five guidelines can help you keep that focus.

Five Keys To Consider Right Now
Be Patient: Investors have fled the markets in droves lately. According to TrimTabs Investment Research, mutual fund investors have pulled $175 billion out of stock funds so far this year, with $56 billion of that capital exodus taking place in October alone. This is the first year that equity flows have been negative since 2002, which reaffirms something we frequently point out: Investors tend to rush in at market tops and out at market bottoms. And that suggests that we may be approaching a bottom – even if it’s not immediately apparent.

Rebalance: Tough markets can really skew your financial perspective. And your portfolio balance. “Rebalancing” can help you get back on track to higher returns, as we’ve mentioned in the past. Not only does rebalancing force you to take profits, but it also encourages you to put more money to work in areas that have been hit the hardest (and which are also poised for the biggest-potential rebounds, studies show).

Look For Consistency: As redemption requests mount and conditions deteriorate, some value funds are shifting managerial styles in an attempt to make up lost ground. Not only does this suggest that these funds never had a strategy to start with, but it also suggests a lack of discipline, which is exactly what we don’t want right now. Studies show that value funds, in particular, tend to rebound more sharply than other investment choices because they’re often chocked full of quality stocks trading at deep – but temporary — discounts.

Make Sure Value Really Is Valuable: “Value” has many different meanings, so it’s important to make sure you understand what the term means when it comes to picking a suitable investment. For some managers, value means companies that are simply trading at steep discounts to other stocks. For others, it means a concentration on those stocks trading in predetermined ranges, perhaps as measured by such indicators as Price/Earnings (P/E) or Price/Book (P/B) ratios. Different definitions can lead to vastly different types of stocks.

When Buying On The Cheap, Understand That Near Term Outlook Often Stinks: During good times, value investing is often about buying companies that, at least in the near-term, have fallen on hard times. Now, however, pretty much everything is “cheap,” so the more important issue is identifying those companies with superior fundamentals and improving outlooks that may simply be caught in this bad-market maelstrom. After all, Wall Street knows the price of everything. But very few people understand the value of anything.

[ucypmas]

Very interesting topic. I have learned a lot just by reading the past posts. Thanks to all the contributors here for sharing your experience.

[la papillion]

Do keep up the post ucypmas. Love reading your views too

[winston]

Beware The Value Trap by Louis Basenese

Consider this your warning...

With thousands of stocks down 50% (or more), investors are salivating over the bargains. But for every true deal, there are at least three "value traps" - stocks destined to languish at depressed levels indefinitely. Or worse, get cheaper still.

Think Kmart here. In late 2001, it became the poster child for value investors. They argued it was dirt cheap based on countless metrics like book value and sales. And it was destined for a historic turnaround.

Sure enough, the stock went from the bargain bin to the trash heap, as the company filed bankruptcy in early 2002.

So before you go bargain hunting in this market, arm yourself with this list. It could be your only chance to avoid getting snared by the countless "Kmarts" begging for your investment...

10 Questions You Should Be Asking

In theory, a value stock is a beaten-down company that's 1) cheap compared to its earnings, its competitors and/or some other relevant benchmark and 2) poised for a turnaround.

In contrast, a value-trap is simply a beaten-down company that's cheap compared to its earnings, its competitors and/or some other relevant benchmark... that never quite turns it around.

Unfortunately, no formula exists to calculate when, or if, a turnaround will ever occur. But, these 10 questions should help. And ultimately, keep you out of most value traps...

Is there a near-term catalyst?First things first, if there's nothing on the horizon - like a new product launch, key marketing arrangement, a shake-up of the executives, the conversion of a massive order backlog, etc. - we shouldn't bother. Companies and stocks need catalysts in order to advance. If none exist in the next 12 to 18 months, chances are the stock will be stuck in neutral, or worse, reverse.


What are insiders doing?
Nobody knows the company - and its future prospects - better than the insiders. If they're not salivating over the "cheap" prices and backing up the truck, we shouldn't either.


Is the company addicted to debt?
Too much debt magnifies the impact of tough times. As sales decrease, interest payments take up more and more of the company's earnings. Not to mention, unwinding leverage is a time-consuming process. So even if the company boasts new, fiscally responsible management, beware. Or as Warren Buffett observes, "When a management with a reputation for brilliance takes on a business with a reputation for bad economics, it's the reputation of the business that remains intact."


Does the dividend yield seem too good to be true?
Value investors love to tout they "get paid to wait" for a turnaround. Granted, many stocks do maintain their dividends through a downturn. But countless others don't. They slash or cancel them altogether, just to stay in business. No matter how tempting, tread carefully when the dividend yield hits double-digit levels.


Is the company just as "cheap" based on the future? At first glance Eastman Kodak (NYSE: EK) appears dirt cheap, trading at a price-to-earnings (PE) ratio of 2.96. But don't be fooled. Or get too easily excited. Remember, the PE ratios cited on most financial websites are historical. And as investors, we don't care what a company was worth... we care about what it will be worth. So before you buy, make sure the stocks forward PE ratio is similarly attractive. (FYI - Eastman's is not. It trades at 27 times forward earnings. Hardly cheap.)


Which direction is the company's market share headed? A general economic slowdown is one thing. But when a company's losing market share, too, that's an indication that a competitor has a better mousetrap. And while economic growth is cyclical, market share is not. Even if the economy or industry turns around, chances are the company's market share won't.


Does the company operate in a highly cyclical or moribund industry?
If you go hunting in a highly cyclical industry (like semiconductors) you're asking for trouble. Same goes for industries destined for obsolescence (like print media). To win with these stocks, you need both the company's misfortunes and the industry's to reverse course.

How's the free cash flow?
Earnings can be massaged, manipulated or completely fabricated. But cash cannot. So make sure free cash flow is stable, or growing. If nothing less, it provides management with a little wiggle room, or margin of error when considering ways to speed up a turnaround.


Is the stock liquid enough?
Just like insiders provide support to share prices, so do institutions (mutual funds, pension plans, hedge funds, etc). Both groups can move stocks prices quickly and significantly. However, many institutions can't or won't buy stocks trading for less than $10, with a market cap below $1 billion and/or that don't trade several million dollars worth of shares each day. Without the potential for institutional ownership, a quick rebound in prices becomes less likely.


Does the company have a sustainable competitive advantage?
For a stock to turnaround we need the company to thrive, not survive. That's not possible without a sustainable competitive advantage. So stick to companies like Apple (Nasdaq: AAPL) that are light-years ahead of the competition in terms of design, market share, new product offerings and/or technology.

In the end, don't kid yourself. Detecting a value trap is no easy task. Even the best investors occasionally get snared. Think Bill Miller (with Countrywide and Freddie Mac (NYSE: FRE)) and Carl Icahn (with Yahoo! (Nasdaq: YHOO) and Advanced Micro Devices (NYSE: AMD)).

But at the very least, these 10 questions will ensure you never buy blindly, or on price alone.

[winston]

Some factors used by a Newsletter to screen for stocks:-

Quantitative:
1. Earnings growth > 50% (and accelerating)
2. Revenue growth > 30% (and accelerating)
3. PEG Ratio < 1.50
4. Debt-to-equity < 0.5
5. Current-ratio > 1
6. Return-on-equity > 20%
7. Management ownership of stock > 10%
8. Double-digit (and increasing) profit margins
9. Market size of $1 billion or more
10. Institutional accumulation
11. Ample liquidity - trading volume >100,000 shares/day
12. Consistently meeting or beating quarterly guidance
13. Positive and increasing operating cash flow
14. Dividend yield < 1%
15. Short interest < 25%

Qualitative:
16. New product or service
17. High barriers to entry
18. Potential recurring revenue stream(s)
19. Superior technology
20. Sustainable first-mover advantage
21. Underpenetrated or virgin market
22. Proven management team
23. Top-tier Venture Capital/Private Equity investors
24. Little or no analyst coverage
25. Adjacent market applications
26. S-curve position - early stages

[kennynah]

11. Ample liquidity - trading volume >100,000 shares/day

this is NOT enough liquidity, imo