Hi there! Value investing requires mastering your own emotions and being confident in your analysis of the company you're investing in. For most people new to value investing, I would strongly encourage reading Warren Buffett's 1977 letter published 40 years ago, which is still 100% relevant today (link: http://www.berkshirehathaway.com/letters/1977.html)
4 Criteria
He suggests investing in businesses where (and I am quoting verbatim here):
(1) one that we can understand,
(2) with favorable long-term prospects,
(3) operated by honest and competent people, and
(4) available at a very attractive price.
Let's go through these criteria one by one, with a (simplified) example/analysis of a real (and complex) company: APPLE INC (NASDAQ: AAPL).
(1) one that we can understand
Do you understand the business of Apple? Where do they make money from? Is it mainly desktops? or Laptops? or iPhones? or watches? Do they also make money from services (music, app store etc)? Do you understand each of these individual products and services well? Or is it too difficult to understand?
(2) with favorable long-term prospects,
Many call this the Moat. Just like the water surrounding a castle prevents intruders from taking down the castle, when evaluating a company, it's important to understand what makes this company special, and likely to thrive (not just survive) for the next decade? Will Samsung be able to beat iPhone with their Galaxy series? Will Microsoft be able to beat iPad with their Surface tablets? Will Windows become so much better than MacOS? Will Spotify beat Apple Music? Will they continue to dominate America? Are they able to conquer Europe and China?
Understanding what constitutes the moat of a company will give you confidence AFTER you invested, ensuring that even when the share price drops, you will not panic-sell.
(3) operated by honest and competent people
The company may be a well protected castle full of treasures, but if the management is not aligned with the best interests of shareholders (you), or the profits are being used for extravagant travel (private jets), then maybe itâs not the best investment to make. You can make your own assessment by reading interviews, watching youtube videos and listening to the quarterly calls. Are they good leaders? Do they come up with actionable strategies or blame others for mistakes? Do they understand the business? One quick tip: The ocean is huge - invest in companies where you will be interested to listen to the senior management. This will ensure that you are kept up to date on the developments. Does Tim Cook (CEO, Apple) know where Appleâs strategic strengths are? Is he spending money frivolously on buying other companies? Is he investing in the right areas? Does he know what heâs talking about?
(4) available at a very attractive price
While you may understand Apple (and may even have queued up overnight for the latest iphones), love the moat, adore the senior management; the current share price of the stock may not make sense. Share prices are dictated by demand and supply of the shares - if thereâs a frenzy of people trying to buy Apple stocks, the price goes up. If thereâs some bad news, the price goes down (e.g. Antennagate) - and NOT by any scientific/mathematical analysis of the intrinsic value of the company. Just look at the stock price of Apple within a day. The price moves up and down like a roller coaster even though thereâs no good (nor bad news) on a daily basis. This should give you an inkling that itâs mostly driven by humans. And this is key. BECAUSE the share price fluctuates without direct relation to the actual business of the company, it gives value investors like us awesome opportunities to buy stocks when they are selling at a discount.
But how do you know when itâs too expensive or selling at a discount? And this is the âscienceâ part. You have to read their annual reports (10-K forms), analyze their balance sheets, income statements, cash flow, do some calculations to determine whatâs a âfairâ price for the shares (thereâs a couple of ways to do this. And no itâs not exact.) As of 26 march 2019, Apple is currently trading around $188.70. After your calculations, perhaps you feel that a fair value is $170. And thatâs where this âattractive priceâ critera comes in. If itâs worth $170 and selling at $188, clearly you shouldnât buy it (note that $170 already takes in consideration your expectations of the future growth of the company). But what if itâs worth $170 and selling at $170? Maybe you shouldnât buy it either. Why trade $170 for $170? But if itâs worth $170 and itâs selling at $136? Thatâs a 20% discount. Even if you got some of your calculations wrong (perhaps you were too optimistic about their future growth rates), that 20% margin-of-safety or buffer should be good enough. But perhaps you are just starting to invest, and not so sure of your calculations. What if it was selling at $102? A 40% discount. Would you be able to stare your brokerage app in the face and click on that BUY button?
Controlling Your Emotions
Yes, i hear you. WHY would a $170 thingey sell for $136? Well... the short answer is: because of EVENTS. A downturn, a scandal, war? One of the emotions that we need to overcome as Value investors is FOMO (Fear-of-Missing-Out). An extreme recent example is Bitcoin - but thatâs a story for another day.
Next Steps
As the cliche goes, a journey of a thousand miles begin with a single step. I suggest reading line-by-line Warren Buffettâs 1977 letter, with a notebook in hand, and take notes. I guarantee that it wonât take more than 30 minutes. And if you like it enough, read Warren Buffettâs 1978 letter, and so on. You could read one of the hundreds of books that tells you how to invest in the âwarren buffett wayâ, but frankly, itâs much more useful if you go back to the original text.
Always interested to know how it goes for you! Let me know!
Hi there! Value investing requires mastering your own emotions and being confident in your analysis of the company you're investing in. For most people new to value investing, I would strongly encourage reading Warren Buffett's 1977 letter published 40 years ago, which is still 100% relevant today (link: http://www.berkshirehathaway.com/letters/1977.html)
4 Criteria
He suggests investing in businesses where (and I am quoting verbatim here):
(1) one that we can understand,
(2) with favorable long-term prospects,
(3) operated by honest and competent people, and
(4) available at a very attractive price.
Let's go through these criteria one by one, with a (simplified) example/analysis of a real (and complex) company: APPLE INC (NASDAQ: AAPL).
(1) one that we can understand
Do you understand the business of Apple? Where do they make money from? Is it mainly desktops? or Laptops? or iPhones? or watches? Do they also make money from services (music, app store etc)? Do you understand each of these individual products and services well? Or is it too difficult to understand?
(2) with favorable long-term prospects,
Many call this the Moat. Just like the water surrounding a castle prevents intruders from taking down the castle, when evaluating a company, it's important to understand what makes this company special, and likely to thrive (not just survive) for the next decade? Will Samsung be able to beat iPhone with their Galaxy series? Will Microsoft be able to beat iPad with their Surface tablets? Will Windows become so much better than MacOS? Will Spotify beat Apple Music? Will they continue to dominate America? Are they able to conquer Europe and China?
Understanding what constitutes the moat of a company will give you confidence AFTER you invested, ensuring that even when the share price drops, you will not panic-sell.
(3) operated by honest and competent people
The company may be a well protected castle full of treasures, but if the management is not aligned with the best interests of shareholders (you), or the profits are being used for extravagant travel (private jets), then maybe itâs not the best investment to make. You can make your own assessment by reading interviews, watching youtube videos and listening to the quarterly calls. Are they good leaders? Do they come up with actionable strategies or blame others for mistakes? Do they understand the business? One quick tip: The ocean is huge - invest in companies where you will be interested to listen to the senior management. This will ensure that you are kept up to date on the developments. Does Tim Cook (CEO, Apple) know where Appleâs strategic strengths are? Is he spending money frivolously on buying other companies? Is he investing in the right areas? Does he know what heâs talking about?
(4) available at a very attractive price
While you may understand Apple (and may even have queued up overnight for the latest iphones), love the moat, adore the senior management; the current share price of the stock may not make sense. Share prices are dictated by demand and supply of the shares - if thereâs a frenzy of people trying to buy Apple stocks, the price goes up. If thereâs some bad news, the price goes down (e.g. Antennagate) - and NOT by any scientific/mathematical analysis of the intrinsic value of the company. Just look at the stock price of Apple within a day. The price moves up and down like a roller coaster even though thereâs no good (nor bad news) on a daily basis. This should give you an inkling that itâs mostly driven by humans. And this is key. BECAUSE the share price fluctuates without direct relation to the actual business of the company, it gives value investors like us awesome opportunities to buy stocks when they are selling at a discount.
But how do you know when itâs too expensive or selling at a discount? And this is the âscienceâ part. You have to read their annual reports (10-K forms), analyze their balance sheets, income statements, cash flow, do some calculations to determine whatâs a âfairâ price for the shares (thereâs a couple of ways to do this. And no itâs not exact.) As of 26 march 2019, Apple is currently trading around $188.70. After your calculations, perhaps you feel that a fair value is $170. And thatâs where this âattractive priceâ critera comes in. If itâs worth $170 and selling at $188, clearly you shouldnât buy it (note that $170 already takes in consideration your expectations of the future growth of the company). But what if itâs worth $170 and selling at $170? Maybe you shouldnât buy it either. Why trade $170 for $170? But if itâs worth $170 and itâs selling at $136? Thatâs a 20% discount. Even if you got some of your calculations wrong (perhaps you were too optimistic about their future growth rates), that 20% margin-of-safety or buffer should be good enough. But perhaps you are just starting to invest, and not so sure of your calculations. What if it was selling at $102? A 40% discount. Would you be able to stare your brokerage app in the face and click on that BUY button?
Controlling Your Emotions
Yes, i hear you. WHY would a $170 thingey sell for $136? Well... the short answer is: because of EVENTS. A downturn, a scandal, war? One of the emotions that we need to overcome as Value investors is FOMO (Fear-of-Missing-Out). An extreme recent example is Bitcoin - but thatâs a story for another day.
Next Steps
As the cliche goes, a journey of a thousand miles begin with a single step. I suggest reading line-by-line Warren Buffettâs 1977 letter, with a notebook in hand, and take notes. I guarantee that it wonât take more than 30 minutes. And if you like it enough, read Warren Buffettâs 1978 letter, and so on. You could read one of the hundreds of books that tells you how to invest in the âwarren buffett wayâ, but frankly, itâs much more useful if you go back to the original text.
Always interested to know how it goes for you! Let me know!