facebookCan someone explain value investing to me in basic terms? It sounds like buy low and sell high now? - Seedly

Can someone explain value investing to me in basic terms? It sounds like buy low and sell high now?

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Lim Boon Tat

07 Jun 2019

Mathematics at Cambridge University

Hi David,

Good question. To understand more, read on - i will use ridesharing to explain this.

Firstly, let me comment: that’s how anyone makes money in general. You acquire an asset for $X (your own time, other people’s time, labour, raw material etc), and perhaps after some processing (or rebranding), sell it for $Y (hopefully Y>X). Buy low, sell high. Or put another way: buy at a price, sell at a higher price.

Value investing is just one of many stock-picking strategies that people have come up with, in order to achieve this outcome (buy at $X, sell at $Y where Y>X)(note: not necessarily in that order in a process called shorting), and the mindset behind it is different from other strategies.

To understand value investing, you have to understand some fundamental truths about the stock markets (and perhaps about humans). With the popularity of ride-sharing apps, i will use grab as example.

Caveat: I am going to use some slightly inaccurate terms below, but it gives you the general gist.

Truth #1: The price in stock markets has “surge pricing” built-in. Shocking? Well, basically what i am saying is that the “equilibrium” price of a stock is determined by demand and supply of the stock. If everyone’s buying and nobody’s selling, price goes up. If everyone’s dumping and nobody’s willing to buy (or just lost their jobs), then price goes down. Surge-pricing.

Truth #2: Humans behave inconsistently and consistently at the same time. They hate surge pricing generally (it’s the same distance, how can it cost $12 before rain, and $30 during rain?), and yet contributes to it (everyone is buying this stock, must be good!)

Truth #3: The stocks you buy represents actual fractional ownership of a real, living and breathing, money-making entity - one with a track record, and actual, real-life, intelligent humans working there for a large part of their waking hours. And for the most part, has predictable growth.

These 3 truths, when combined together, simply tells you this: The price of the stock you see fluctuates on a daily basis (because of “surge-pricing”), but once you buy it, you own an actual business with predictable growth. “Price is what you pay, Value is what you get”.

To succeed at value investing requires identifying “mispricing” - that it’s selling below its actual value (“Jurong to Orchard is only $9! Good deal!)(note: actual trip on gojek). Bargain hunters in general, are genetically primed for this activity. Somehow they know the “intrinsic worth” of an item, and when they see it being sold cheaply at a flea market, or a “closing-down” sale, they snap it up, safe in the knowledge that they have bought something that can be resold at a higher price because of its “intrinsic value”.

To explain how to calculate the intrinsic value, will take up many thousands of words. But I assure you, no differentiation or integration required. All of us intuitively can feel “fair value” or “good deal” when it comes to a ride because we do it regularly. When it comes to investing, it’s the same: Do it regularly, study the market, understand what’s fair value and what’s a good deal or when it’s ripping you off, and you will do well in the stock market. Unfortunately, most people study the prices between gojek and grab and comfort more regularly than they do investing.

And THAT is value investing, using ridesharing as an example.

Let me know if this analogy works!

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The best way to think about value investing is to compare it with discounted shopping.

There is a new Smart TV released in the market. As a shopper, I did some research and found that it has several awesome functions that I like. But when I see its price tag, I gawked at the lofty price; probably because it is still a new product and there's a lot of hype about it. I thought to myself, it can't be worth that much.

Over the next few months, I keep a lookout on that TV and monitored its price. Finally, the Great Singapore Sale arrived and there was a 15% discount from its recommended retail price. Sounds like a steal!

But I wait out for a deal. I window-shop and stared at the 15% discount daily until I found a display unit selling at an additional 10% off.

Ahh! I thought to myself. The Smart TV that I've been watching out for the past few months is finally selling at a solid 25% discount; its awesome functions and features remain unchanged. Then, I swoop in to buy the discounted unit.

In sum, value investing is like looking for a deal. You want to buy a good stock with solid fundamentals at a fair (or even discounted) price.

Chris Susanto

05 Apr 2019

Founder at Re-ThinkWealth.com

I wrote a guest post for dollars and sense before sharing about what is value investing and why does...

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