Month: June 2014

The What and Why of Value Investing and Security Analysis

Wow! I realize that it’s been a while since I’ve posted on this here blog, but to anyone who still follows me fear not I am still alive and writing. As student having recently graduated high school and being busy with all of the things that come with that I’ve been busy. I am free however now and will continue to post on here weekly when possible.

Alright, in this post we’ll be shifting gears a little bit and talking about how what our goals are with investing and how we are going to go about attempting to achieve them. As I’ve noted in previous posts, the primary reason to engage in any kind of investment is to assure that the investor’s wealth is growing faster than inflation, that is a rise in the overall price level, corrodes that wealth’s buying power. This is also the bare minimum an investor must accomplish in order to make any kind of investing activity worthwhile. However if keeping up with inflation is all we wanted to do then we could just buy bonds or index funds that accomplish just that goal. What most investors would prefer, in my humble opinion, is to grow their wealth as much as possible while still conserving the principal amount of their investment. So with this new goal in mind one might ask why just bonds, or investment company instruments like mutual funds, ETFs, or UITs would not suffice. I am not going to lie; instead I’ll say those securities could very well fit the needs of an individual investor and even those of some institutions but for those who are interested in earning greater returns than those of the indexes and far greater returns than any bond could actually deliver, value investing is that way to go.

If you’ve never heard of value investing(which is actually quite popular in the investing community) then you may be wondering what it is or what makes me speak so highly of it. If you’re already into it then just hang on for a bit as I explain it. Value investing is not a magic formula that is going to magically make you rich, it’s not a trading or signal system, and most importantly it is not a scam. In short Value investing works by purchasing a stock that an investor is reasonably certain is selling below the true value of the fraction of ownership in a business that the stock represents and then waiting for the stock price to reach what the investor believes to be the intrinsic value of the stock and then selling it. As you might have inferred the greater the discount at which a stock is selling from its intrinsic value the greater the profit per share the investor make upon selling it at that fair price. This begs the question, how do we ascertain the intrinsic value of a stock or any other investment security? Well in order to that we have to engage in security analysis of multiple types, but they all boil down too what I explained in my last post: time value of money as well as a little bit of accounting. What value investing and security analysis do not entail is any kind of technical analysis or using past prices or price changes to predict future ones. Benjamin Graham, the father of value investing, and Warren Buffett’s graduate professor and former employer, once wrote in his famous book The Intelligent Investor “Investing is most intelligent when it is most businesslike.” By using analyzing the business behind a stock and it’s true value, we are treating our investment, even at the individual level as a business undertaking and thus are being more prudent about it.

In any case, one thing should be noted if your skill in value investing does not earn you greater returns than those of the major stock market indices it may be best to stick to using index funds until you get the hang of it or until such a time as the market presents you with a larger amount of or more deeply undervalued stocks. This is not to draw you away from value investing but to have you understand that this strategy is a long term strategy, a waiting game if you will. Waiting until your undervalued holding finally reach their true value or to liquidate yielding more than you paid for the stock, or waiting until you find an deeply undervalued stock as you search through the thousands of publicly traded equities in the world. This waiting could take weeks, months, or even years but the people with the patience and the discipline not to sell an undervalued stock are the ones who earn the greatest returns.

In my next post I seek to get in to the practical aspects of security analysis and how to get started with analyzing and valuing a business. In the mean time I recommend reading this website, which does a MUCH better job of explaining basic accounting than I ever could. While it may be possible to understand my next few posts without reading up on accounting I would highly recommend it, and I think accounting is actually more interesting than the media may lead you believe.

Disclosure: The author is not an attorney at law or a finance professional. He did not own any securities at the of this post’s writing and is not receiving any compensation for this post.

If anyone has any questions just post them in the comments section below.

-Mohit D. Patel

Author, The Not So Intelligent Investor