Value Investing 01 (May 08 - Dec 08)

[winston]

The Other Measure of a Company's Worth By Andrew Gordon

Price-to-earnings ratio (P/E) is a popular measurement of a company's true worth. I've always liked companies with a P/E below 10. But nowadays, I pay little attention to this number - for two reasons, and both involve the earnings part of the ratio...

1. The economy is slipping so fast, past-performance P/Es shed little light on what is in store for the company right now. Many companies that did well 1-3 quarters ago are now finding it hard to grow earnings.

2. Forward P/Es are just as bad. They've always been based on analysts' guesses of how much they think a company will earn the following year. But now those guesses - never reliable in the first place - are lagging badly behind what is happening in the real economy. For example, analysts still expect earnings in the tech sector to rise 21 percent next year. That simply won't happen.

As an alternative, look at the price-to-book ratio (P/B). It measures a company's share price relative to its net asset value (NAV). If that number is below 1, it means you're paying less for the company than its assets are worth. And it means you're getting the business of the company (not included in the NAV) for free. A P/B of less than 1 also helps put a floor under share prices, especially for companies that are still making a profit but are getting punished by a falling market.

Buying good value is not only a good way to pick companies in a falling economy, it's the only way. And with earnings so unpredictable, P/B is a good alternative to P/E as a measure of value.

[kennynah]

the price-to-book ratio (P/B). It measures a company's share price relative to its net asset value (NAV). If that number is below 1, it means you're paying less for the company than its assets are worth.


LOVL !!!

[Cheng]

A question for myself to take note/action.

What is stopping everyone from buying good companies these past few weeks? Be greedy when others are fearful.

[cif5000]

What is stopping everyone from buying good companies these past few weeks?

I think one reason could be that there are plenty of cheap and good purchases available and we are frozen into inaction. It is like if you go hunting and then a rabbit jumps out from the bush, you aim and shoot. But when a herd of deers come jumping in your direction, you don't know which one to aim at. Perhaps we can stop looking for the rabbit.

And then we see from the market that everyone else are also not buying, psychologically we feel that we are doing the right thing (social proof).

Because the cheapness has stayed for a while, we lost that contrast. Contrast is emotionally important. If Capitaland was $10 yesterday and today it is $2.50, that's a sharp contrast. We can feel the bargain. But if the stock has hovered around the same range for the last few months, the lack of contrast will tell us that there is no cheapness (Note: not implying the Capitaland is a good buy, just using it as an example). Just like COE. Before there were COE, you pay $0. And then when the CEO was a few thousand dollars from tens of thousands, you feel the cheapness, even though it cuts you back by a few thousand.

[Cheng]

And then we see from the market that everyone else are also not buying, psychologically we feel that we are doing the right thing (social proof).

Because the cheapness has stayed for a while, we lost that contrast. Contrast is emotionally important. If Capitaland was $10 yesterday and today it is $2.50, that's a sharp contrast. We can feel the bargain. But if the stock has hovered around the same range for the last few months, the lack of contrast will tell us that there is no cheapness (Note: not implying the Capitaland is a good buy, just using it as an example). Just like COE. Before there were COE, you pay $0. And then when the CEO was a few thousand dollars from tens of thousands, you feel the cheapness, even though it cuts you back by a few thousand.

Agree on that!

But if we are comparing based on prices alone, might be delusional because we don't expect prices to rise back to previous highs again. I'm sure we will all agree to buy based on valuations instead.

Buy good companies and be prosper everyone!

[kennynah]

so, why not buy now, which is the original question...given great valuations abound, according to "valuators" ?

[cif5000]

The problem with "value investor wannabe" is that their eyes and thoughts are too fixated on the market. They preached that "the market is both a voting and weighing machine" and yet get manipulated by the daily prices. They lose the confidence when the price drops and say that it is a good opportunity to buy more but secretly cursing their poor fortune.

Now...after some beer....It is like inner beauty and outer beauty. Wise man advises that when choosing a mate, outer beauty (stock price) is not as important as inner beauty (real worth). Outer beauty will make the heart pump faster but that adrenalin sensation fades after a while. And when it is gone, you are stuck. (too late to cut cost). Value investing is like choosing a mate. If you want just want it for this Friday night, care what about the inner beauty. Tomorrow she will be gone. But wise man says to choose a woman with inner beauty if you want to live with her for long.

Here comes the problem. When there is no outer beauty (i.e. stock price falling), are you certain that she has the inner beauty?

[kennynah]

great FA....

beer and outer beauty ... better combination, i think....enjoy

[Cheng]

The problem with "value investor wannabe" is that their eyes and thoughts are too fixated on the market. They preached that "the market is both a voting and weighing machine" and yet get manipulated by the daily prices. They lose the confidence when the price drops and say that it is a good opportunity to buy more but secretly cursing their poor fortune.

Now...after some beer....It is like inner beauty and outer beauty. Wise man advises that when choosing a mate, outer beauty (stock price) is not as important as inner beauty (real worth). Outer beauty will make the heart pump faster but that adrenalin sensation fades after a while. And when it is gone, you are stuck. (too late to cut cost). Value investing is like choosing a mate. If you want just want it for this Friday night, care what about the inner beauty. Tomorrow she will be gone. But wise man says to choose a woman with inner beauty if you want to live with her for long.

Here comes the problem. When there is no outer beauty (i.e. stock price falling), are you certain that she has the inner beauty?

I need that, thanks for the lesson.

Not cursing the market though, just hesitant to buy.

[Cheng]

http://www.bigfatpurse.com/2008/12/buy-and-hold-is-not-as-easy-as-you-think/

I am not against buy and hold strategy. Instead, I believe it can really bring you great wealth - note that the world’s richest investor is a buy and hold strategist. Many investors are familiar with this strategy and often practice it, but not many are successful. Here are some of the reasons that may have caused their failure:

1) Fail to plan for future money needs

Many people are myopic such that they only see the near future of 3 to 5 years ahead, and some may even see shorter than that. When it comes to investing, they foresee they do not need the money and are willing to part with their money and invest in stocks for the “long term”, so as to grow their money. It is good that they are doing something for the future, but they have not considered a possible big purchase or major financial commitment may arise few years down the road. The major financial commitment can be marriage or buying a house. In order to free up some capital, they would usually liquidate the stocks. They would be very lucky if they can make a small profit, as buy and hold strategy is only profitable long term, safely to say 10 years and above.

Thus, it is important to know what your potential money needs in the future before you invest with buy and hold strategy. Do make sure you really do not need the money for any kind of events, either fortunate and unfortunate. Set aside a sum of money before you invest so you do not need to liquidate prematurely.

2) Weak psychology towards market downturn

As a buy and hold strategist, you cannot afford to be affected emotionally by the ups and downs of daily stock movement. Warren Buffett mentioned that he does not care if the stock exchange closes for 10 years! Unsuccessful buy and hold strategist tends to hold when losses are small, but when the losses sustain further, he or she may not have the tenacity to hold anymore and will liquidate the stocks.

Investors with weak psychology cannot endure the pain of holding when the chips are down. During a downturn, a 50% reduction in their portfolio is normal, and how many investors would be able to handle the pain?

3) No discipline and determination

As we mentioned previously, buy and hold strategy would most likely be profitable 10 years and above. However, you may be able to buy near a market bottom and make a small gain when the market recovers in a year or two. You would feel good about yourself and sell your holdings to realize the profits. The success ingredient in buy and hold strategy is time. You have to understand the power of compound interest, where your profits will grow exponentially. Your capital doubles, triples, quadruples, or more, depending on the time horizon you are invested. This is the edge that the strategy can give you. If you have no patience for a good 10-20 years minimum, you basically lost the edge.

Very good article to remind me.
To add on: When you buy and hold, make sure the company is strong, No. 1 or 2 in the industry and have to foresee 10-20yrs from now that they will still be relevant. Not buying at overpriced levels.