Value Investing: An Introduction
An introduction to Value Investing
Dr. Tejinder Singh Rawal
Chartered Accountant
tsrawal@tsrawal.com
Stock market is a crazy world. Different players enter the market with different time-frame, and with different intentions. Some look for quick bucks, and would cash on the market momentum, totally ignoring the market and stock fundamentals, while for some it is a casino, where they would make or lose money as if by a flip of coin, these people usually day-trade, as they look for quick results. Then there is a small, albeit committed tribe of value investors, who would invest only when they find that a share is being traded at a price below its intrinsic value. Value investors believe that the efficient market hypothesis is not valid, and more often than not, there would be a divergence between the real value of a share, and its quoted price. The wining strategy lies in finding the true net worth of a share, and buy a share only if there is , what the great-father of value investing Benjamin Graham referred to as, the Margin of Safety in the deal.
This article is an introduction to the discipline of Value Investing, as developed by Benjamin Graham, and successfully practised by great investors like Warren Buffet, and Peter Lynch. This approach is more scientific than any other approach, and is more suited for the academic and professional backgrounds of Chartered Accountants and other finance professionals, since it requires a detailed knowledge of the financial statements, and an ability to calculate the real net worth of a company. In the following paragraphs, we discuss the Value Investment strategy.
Invest for the long term. When Keynes said, in the long run we are all dead, he was certainly not referring to the stock market. The success in stock market largely depends upon your ability to stay invested for a long period. It is strange few people heed this advice! Most investors in Indian markets continue to be short-term investors, and speculators. Day trading is an important characteristic of Indian stock markets. Short-term investment is nothing more than a speculation, and you can rather try your luck at horse races, or at casinos where the probability of success is higher!
Do not time the market. A Value Investor does not try to predict the direction the market is going to take. You should not wait for the market to rise or fall before you decide to invest. Since as a long-term investor you will be focussing on the value of individual share, rather than the frenzy of the market, market direction should not be a cause of concern, as long as you are sure that the investment you are making is attractive, and has a sufficient margin of safety built into it. As a long-term investor, you should not hold your cash, waiting for the market to fall, so that you can invest when the prices are low. You should know the time value of money, which means that the early you invest the higher will be your return. Moreover, if you invest regularly, you are able to take advantage of ‘rupee averaging’, which takes care of market fluctuations.
Do your homework. As a value investor you should know the fundamental value of the share you are buying. Remember that PE ratio is not the acid test of investment. Low PE ratio does not on its own make a particular company worthy of investment, and high PE , per se, does not make a share less attractive. Other factors like the quality of management, break-up value of the share, debt-equity ratio, interest coverage ratio are equally important.
Do not invest in penny stocks. Penny stocks and junk scripts look attractive to the investor when the indices are rising, since the price of these shares usually rise faster than the rise in prices of other shares. However, then the market falls, the investor is left with junk, which has no value. As a matter of principle, you should invest in stock of the only such companies whose fundamentals are known to you. Do not depend on tips , however reliable the source of tip may be. Most of the tips are generated by people with vested interest. Even when the source of the tip is genuine, the time frame the issuer has in mind may be different. If you are tempted to act on a tip, study facts before you decide to go ahead.
Do not panic. This is very important. More money is made in stock market by remaining inactive. It is foolish for a long-term investor to be excited or subdued by the market ticker. CNBC channel is for the short-term traders and day-traders, do not let the opinions expressed there affect your investment decision. If you are confident your investment is fundamentally strong, every fall should give you an opportunity to buy rather than sell. Of course, while you do that keep in mind the principle I have narrated in the next paragraph.
Don’t pull your flowers and water your weeds. This strong advice comes from Warren Buffet, the most successful disciple of Ben Graham. The greatest mistake most investors make is to sell the shares that have appreciated, and hold the ones, which are giving a negative return. The investment strategy should be the other way round; you should sell the losers and let the winners ride. I do not mean that you should sell every share that has depreciated. The right course is to keep pruning your field regularly to identify the weed so that they could be removed, and to identify the flowers that should be watered as long as their fundamental value is below the prevailing market price.
Do not invest in the company and sector whose business you do not understand. If you can understand a business and you find value there, invest. Do not be tempted to invest in industry about which you do not have much idea. While there is so much money to be made in technology shares, yet if you do not understand the business, it is better you do not go into it. My personal investment philosophy is to invest in the business, which I would be comfortable running on my own. I apply the same principles even when my investment is as low as 10 shares.
Do your own research. Security analysis is not as difficult as it may seem. You do not have to be a qualified analyst to do the analysis. When I say that more money is made by being inactive in the market, I certainly do not mean that you should invest and forget. On the other hand, you should keep reviewing the performance of the company you have invested in. If there is a fundamental change in the situation of your company, which has altered the premise based on which you had bought the shares, decide if the change warrants a change in your portfolio.
These principles have been perfected by masters and are time-tested technique for long-term investment in the market. While this is not the only way one can invest, this method is more scientific and if applied consistently, it would make the process of investment a less risky proposition with higher margin of safety.
Suggested reading:
Security Analysis by Benjamin Graham
Beating the Street by Peter Lynch
One Up on Wall Street by Peter Lynch
The Intelligent Investor by Benjamin Graham
Common Stocks & Uncommon Profits by Philip A. Fisher
Buffettology by Mary Buffett
Dr. Tejinder Singh RawalM.Com, MA( Economics and Public Administration), LLB, FCA, ISA, CISA, CISM, PhDChartered AccountantE 13, Anjuman Complex, Sadar,Nagpur 440 001 IndiaPh: +91 712 2582923 Fax +91 712 2583522Email: tsrawal@tsrawal.com
Dr. Tejinder Singh Rawal
Chartered Accountant
tsrawal@tsrawal.com
Stock market is a crazy world. Different players enter the market with different time-frame, and with different intentions. Some look for quick bucks, and would cash on the market momentum, totally ignoring the market and stock fundamentals, while for some it is a casino, where they would make or lose money as if by a flip of coin, these people usually day-trade, as they look for quick results. Then there is a small, albeit committed tribe of value investors, who would invest only when they find that a share is being traded at a price below its intrinsic value. Value investors believe that the efficient market hypothesis is not valid, and more often than not, there would be a divergence between the real value of a share, and its quoted price. The wining strategy lies in finding the true net worth of a share, and buy a share only if there is , what the great-father of value investing Benjamin Graham referred to as, the Margin of Safety in the deal.
This article is an introduction to the discipline of Value Investing, as developed by Benjamin Graham, and successfully practised by great investors like Warren Buffet, and Peter Lynch. This approach is more scientific than any other approach, and is more suited for the academic and professional backgrounds of Chartered Accountants and other finance professionals, since it requires a detailed knowledge of the financial statements, and an ability to calculate the real net worth of a company. In the following paragraphs, we discuss the Value Investment strategy.
Invest for the long term. When Keynes said, in the long run we are all dead, he was certainly not referring to the stock market. The success in stock market largely depends upon your ability to stay invested for a long period. It is strange few people heed this advice! Most investors in Indian markets continue to be short-term investors, and speculators. Day trading is an important characteristic of Indian stock markets. Short-term investment is nothing more than a speculation, and you can rather try your luck at horse races, or at casinos where the probability of success is higher!
Do not time the market. A Value Investor does not try to predict the direction the market is going to take. You should not wait for the market to rise or fall before you decide to invest. Since as a long-term investor you will be focussing on the value of individual share, rather than the frenzy of the market, market direction should not be a cause of concern, as long as you are sure that the investment you are making is attractive, and has a sufficient margin of safety built into it. As a long-term investor, you should not hold your cash, waiting for the market to fall, so that you can invest when the prices are low. You should know the time value of money, which means that the early you invest the higher will be your return. Moreover, if you invest regularly, you are able to take advantage of ‘rupee averaging’, which takes care of market fluctuations.
Do your homework. As a value investor you should know the fundamental value of the share you are buying. Remember that PE ratio is not the acid test of investment. Low PE ratio does not on its own make a particular company worthy of investment, and high PE , per se, does not make a share less attractive. Other factors like the quality of management, break-up value of the share, debt-equity ratio, interest coverage ratio are equally important.
Do not invest in penny stocks. Penny stocks and junk scripts look attractive to the investor when the indices are rising, since the price of these shares usually rise faster than the rise in prices of other shares. However, then the market falls, the investor is left with junk, which has no value. As a matter of principle, you should invest in stock of the only such companies whose fundamentals are known to you. Do not depend on tips , however reliable the source of tip may be. Most of the tips are generated by people with vested interest. Even when the source of the tip is genuine, the time frame the issuer has in mind may be different. If you are tempted to act on a tip, study facts before you decide to go ahead.
Do not panic. This is very important. More money is made in stock market by remaining inactive. It is foolish for a long-term investor to be excited or subdued by the market ticker. CNBC channel is for the short-term traders and day-traders, do not let the opinions expressed there affect your investment decision. If you are confident your investment is fundamentally strong, every fall should give you an opportunity to buy rather than sell. Of course, while you do that keep in mind the principle I have narrated in the next paragraph.
Don’t pull your flowers and water your weeds. This strong advice comes from Warren Buffet, the most successful disciple of Ben Graham. The greatest mistake most investors make is to sell the shares that have appreciated, and hold the ones, which are giving a negative return. The investment strategy should be the other way round; you should sell the losers and let the winners ride. I do not mean that you should sell every share that has depreciated. The right course is to keep pruning your field regularly to identify the weed so that they could be removed, and to identify the flowers that should be watered as long as their fundamental value is below the prevailing market price.
Do not invest in the company and sector whose business you do not understand. If you can understand a business and you find value there, invest. Do not be tempted to invest in industry about which you do not have much idea. While there is so much money to be made in technology shares, yet if you do not understand the business, it is better you do not go into it. My personal investment philosophy is to invest in the business, which I would be comfortable running on my own. I apply the same principles even when my investment is as low as 10 shares.
Do your own research. Security analysis is not as difficult as it may seem. You do not have to be a qualified analyst to do the analysis. When I say that more money is made by being inactive in the market, I certainly do not mean that you should invest and forget. On the other hand, you should keep reviewing the performance of the company you have invested in. If there is a fundamental change in the situation of your company, which has altered the premise based on which you had bought the shares, decide if the change warrants a change in your portfolio.
These principles have been perfected by masters and are time-tested technique for long-term investment in the market. While this is not the only way one can invest, this method is more scientific and if applied consistently, it would make the process of investment a less risky proposition with higher margin of safety.
Suggested reading:
Security Analysis by Benjamin Graham
Beating the Street by Peter Lynch
One Up on Wall Street by Peter Lynch
The Intelligent Investor by Benjamin Graham
Common Stocks & Uncommon Profits by Philip A. Fisher
Buffettology by Mary Buffett
Dr. Tejinder Singh RawalM.Com, MA( Economics and Public Administration), LLB, FCA, ISA, CISA, CISM, PhDChartered AccountantE 13, Anjuman Complex, Sadar,Nagpur 440 001 IndiaPh: +91 712 2582923 Fax +91 712 2583522Email: tsrawal@tsrawal.com
posted by Dr. Tejinder Singh Rawal at 11:58 pm
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