Value Investing on the ASX

I confess to being a value investor, but with a bit of a hot head at times.

I have bought and sold a few shares on gut feel, and worse still, based on something I've read in newspapers etc - most likely written by someone who knows less than I do about the company. (I'm still dark with myself for selling >$10k in Jubilee Mines at $6.81 in October 2005, because some uninformed guy expressed doubts about JBM's mine capacity... JBM is around $17-18 now).

Why doesn't everyone do it? Pretty simple really:
- Value investing is a buy and hold approach (Warren Buffet never sells!). This doesn't easily fit with fund managers' needs for quarter-on-quarter performance. It's believed that you can't have a good quarter if you don't "take your profits".
- The returns might take a long time. You might find value in a company, but it can continue to fly under the radar for a long time. (But the hope is that the returns will be lucrative and worth hanging on for).
- Company analysis can be very dry and technical, and requires scrutiny of company accounts, reports, shareholder and directors' movements, etc.

You can't go broke taking a profit! How many times have you seen that in print? Well, I ask this question: After you've paid your CGT, and you have less to invest, what are you going to buy? Why not buy back 75% of the shares you just sold, if the company still represents good value buying?

 

AH HA! - I knew it. I'm sure there's more of you here in Invested...

Well, this is what I'm going to have to have a crack at then - if it's too painful, then I'll have to go back to indexing/ETF's for my sharemarket games.

GSJ

 

What would a 13 year old say... LOL.

(Matt Giteau almost scored a second try against the Springboks. Aus 13 SA 10. C'mon.)

(Stirling Mortlock penalty, Aus 16 Sa 10 after 37 minutes. And a Springbok in the bin. Bewdy.)

I also suggest that you need to keep an eye beyond a company and its accounts, and consider "the big picture".
It's a fairly volitile time right now (and that can present wonderful buying in market dips!).
But smaller companies can find themselves embroiled in unexpected situations, that may be due to government policy (eg managed investment schemes), global interest rate movements, technology changes, anything.

Perhaps the most basic question to ask is, "If I could afford it, would I buy the whole company?"

(And I know that you're not planning to tear out all the assets/cash and gear it up like crazy, and make a few hundred million in fees - although it works for some!).

Good luck with it all GSJ. I've learned pretty quickly that we're amongst 'friends' here in Invested.

(Half time. Aus 16, SA 10. Keep it up, boys.)

 

Just a couple of things to think about, if only to give you another viewpoint:
How do you determine "value"?
Is it calculated by determining the companies net asset values per their financial statements divided by the number of shares issued, and if that number is below the current market price then that is a value stock? Or is it perhaps based on your own gut feel about how a company is performing, whether current practices are likely to growth the business substantially, maybe net present value of future (estimated) earnings or some other discretionery factor?
There are a massive number of highly qualified and highly paid professionals whose sole job it is to plough through such fundamental information to give to their fund managers. Do you think you will be able to do a more thorough analysis of a company than they would? What part of the long term growth prospects of a company would you understand that they have missed (they would have to have missed it in order for the stock to qualify as a "value" asset, if they understood it then surely the shares would roughly reflect that value anyway, thus giving no possiblity of locating a "value" stock)?

I know people will point to someone like Warren Buffet saying "look, he is so rich and I heard that he is a value/fundamental investor". That is perfectly well and good when you have enough resources to go in, buy a controlling interest in a company and CHANGE the fundamentals. To me this is not so much value investing as it is value-add investing. Unless you are keen on pooling resources with a few millionaire mates, then this type of "investing" is not really viable for the average joe.

 

For all "value" lovers below Enron's saga may give you second thought.

http://www.invested.com.au/79/efficient-market-what-share-really-worth-387/?highlight=Enron

PS. Coopranos - good post !!

 

Hi Coopranos,

Don't think for one single minute that these "institutionals" know more than you or I. 90% of them are just kids and they get it wrong as much as anyone else does (if not more - see hedge fund returns).

You cannot equate net asset values with prices as that does not give any value to an ongoing business. i.e. A truck might be worth $x, but a transport business that uses that truck and has good long term transport contracts is surely worth much much more.

I guess there are many flavours of investing that come under the term "value investing". i.e. There are some that follow a pure quantitative approach by buying business with high BtM or low P/E etc., then there are others that anaylse a business as a whole to work out its intrinsic value and then only buy when the market is providing a good price compared to that value.

In reality we should all be "value" investors based on the meaning of the word: value. What other option is there? The pay-too-much investors? Or the there-will-always-be-a-greater-fool investors?

In any case, the more people that aren't value investors, the better it is for us value investors.

Jason.

 

Come on mate, that isnt true at all. These guys are highly paid highly educated experienced people with access to fundamental analysis resources and inside contacts that you or I couldnt hope to achieve. To think that a 3 hundred million dollar fund manager trusts their future to "kids" seems a little naive. They are doing what the average "value investor" attempts to do, just with a whole lot more tools to do it with. The only saving grace for the average fundamental investor is that the markets dont move on fundamentals, they move on emotion - the very fact that they do get it wrong as much as anyone else simply proves this point.

Ok, then the truck is worth $X, and the contract is worth $Y, but the share price is $ZZ.01 and may be worth $ZZ.09 by the end of the day. Why the difference? Both the truck and the contract are easily quantifiable using net present value of the contract and forecasting the useful life of the truck.
The share price should then be $X + $Y = $Z, which would not fluctuate.
Why the difference? The equation is missing $E, the emotion of the mob, which is impossible to quantify. If something is impossible to quantify then it makes no sense to say "that is good value". Compared to what?

Investing only in companies that pay high dividends, or have a good long term track record of growth I understand completely. Buying when the share price is below some determined value of a business?? Seriously?? Even completely ignoring the idea that someone can sit at home with their fin review and past annual reports and determine what an international company is "worth", that relies on the market analysts to get it wrong, and not realise their mistake until after you have purchased (again this is different if you have the capital to actually gain a controlling share and add value). The question is why is the share price below the underlying value of the business in the first place? If there is a reason the share price could have dropped below the "market value" what is to say that it will go up again? Sure you may be RIGHT about the price being less than the underlying asset, but what if it takes 5 years for the market analysts to realise their mistake? What if during that 5 years the price continues to plummet? What if you see 90% of your purchase price disappear before that market finally realises it's "mistake"? All I know is that RIGHT isnt worth a whole lot when the bank repos your home.

Again, you are assuming the share price is in any way reflective of the underlying asset. All your examples are linked - value, pay-too-much, always-be-a-greater-fool - all of these assume that there is one single "correct" price. What is this correct price and how is it determined? I would offer the following: whatever the current share price is PERFECTLY reflects $X + $Y + $E. The current share price is the number that represents all the available fundamental, technical, gut feeling, and any other information about a business from the market analysts with millions of dollars worth of research at their finger tips, to the cowboy who trades his SMSF on penny stocks, to the grandparents who brought shares in Coles back when Adam was a boy.

As always I stand to be corrected on any post, and for the educational edification of all (myself included) I look forward to the attempt!

 

Being highly paid has little to do with it. I have no doubt that there are some fantastic experts out there, but placing all institutional investors in the bucket is simply wrong. From knowing some anaysts myself, they all make dumb mistakes like anyone else, some pay too much for a company when they know its overvallued but everyone else is buying it, some are worried about tracking error from the index, etc.
In fact these guys are the market, so as you say if the market is all-over-the-place, that means these institutional investors are all-over-the-place. so what have their fancy degrees done for them then or their supposed inside knowlegde.

Exactly my point Coopranos - this is why good buying opportunities often present themselves when the fundamentals of a business are still good.
For example: if you are the owner of an un-listed business and you turn on the news one day to hear the stock market has dropped 10% - do you panic that your business is now worth 10% less..? No.



You've used my analogy of the trucking business all wrong. Price is *not* value! I was simply showing that an economically-viable business is worth more than just its assets.


I am not saying that the markets perfectly price stocks at the true intrinisc value of businesses - I personally think thats utter rubbish although EMH believer might not agree. What I am saying is that you can estimate the value of a business and then use that estimate to base your buying, selling decisions. Of course, your estimate will not be perfectly right - no matter how many so-called experts you have to value a business they all come up with different answers... But, I'd rather be almost right than totally wrong.


If you were to buy an entire business, would you buy it without even trying to calculate it value? Of course not. So why then, wouldn't you try to calculate that businesses value if you were only interested in buying a part of it - i.e. a share?

 

The vast majority of analysts are focussed on the top 50 stocks; some are troweling through the ASX100; even fewer are reviewing the top 200. In the small cap world, there are dozens of companies that are not analysed at all. This is where the average joe has his best chance.

But do you chance your arm at small and micro cap stocks only? I reckon a prudent strategy is to have a base of top 50 stocks, that might be 50-75% of your portfolio. The cream can come from stocks that are under the radar of 99% of fund managers.

Does small-cap value investing work? Check out Paradice The philosphy behind Paradice Investment Management which has turned 33.9% pa in six years since inception.

 

Yes, that makes sense, and I would agree.

Exactly!

GSJ

 

Very interesting, I just didn't realise that so many companies in the ASX 200 would be off the radar of so many fund managers.

Thanks,

GSJ

 

You are using analogies of becoming a business owner (in a sense that you would have control) to describe action on a market. Again, what are you comparing value to? What you are saying sounds very much like the Buffett approach, which is a sound approach IF you can gain control to value-add.

Although every other point is subject to our own interpretation and different approch, this is the only point on which I will suggest that you are. You (or any other private investor) have absolutely NO chance of valuing an ASX 200 company with anything remotely resembling "almost right". I am not being harsh on you or anything, but this is impossible. The complexity of these companies makes it difficult enough for professionals who are privy to private information about internal business processes etc, much less a private investor who only has access to google and some reported financial statements. If you work out a way to give an "almost right" valuation of a complex international business from your lounge room, forget the share market you will be a billionaire consulatant.

Again, you are not buying a business in that sense. You are buying a peice of paper that has no real intrinsic value that is traded on a market made up of emotional crowds. Although the notion of my 200 telstra shares giving me any sort of interest in the company at all is nice, it is a pure fiction.

 

It's very difficult to create/formulate a model to accurately predict intrinsic value. Fundamental analysts assume that markets behave rationally. We all know that markets behave irrationally.
Unfortunately market is made up of many opinions of intrinsic value, so to determine real value is just another prediction.

Sometimes I wonder what "value" investor may think today, if he/she bought Telstra shares (TLS) six years ago at or above $7. What chances this investor have got to get his money back and when ?

Unfortunately you have got NO control over shares you bought.
Practically the only thing trader/investor can control is amount of money he/she is prepared/willing/afford to lose in the market.

 

Control has nothing to do with it. Making an estimate of the intrinsic value of a business at a point in time has nothing to do with who controls it. If the current management were not that great then that may affect your required return of course.
Calculating intrinsic value is a mathematical technique based on the numbers in the financial statements - whether you think the business is low or high risk etc comes in to the required return you need.

Yes WB does state that he uses this line of thinking in his letters to shareholders, but it has nothing to do with control or value-adding. In fact he publicy states that he wants to have nothing to do with the running of the business he owns as their current managements know much more about it than he does. If you'd have read any material on WB you'd see he's not interested in buying businesses that need "turning around". He wants to buy business that are already fantastic businesses. And he buys them when he believes they are trading at a discount to intrinsic value and holds for the long term. i.e. Value Investing.

Each to their own I guess. However, I can quickly come up with a rough valuation of intrinsic business value on an asx200 stock quite quickly given a number of years worth of publicly available financial statements.

Can I ask if you have read anything on W.Buffett? P.Fisher? B.Graham, etc? As I am only re-iterating what I and many others have learnt from them.

 

The other thing I would add is that no matter what sort of debate goes on, you must find a strategy that suits you. The beauty of the markets is that 2 people can have perfectly opposite views on how things work, yet both can make money or lose money at the same time. 2 people can have exactly the same view on how things work, and 1 can make money and the other can lose money. It is one of those interesting things...
While I do think it is a good idea to look at all sides of an argument, everyone has to make their own mind up about how they see things. Possibly the best lines of advice I have ever heard was on a Jim Rohn tape: "Make sure that whatever you do is the product of your own conclusion".
Look at all sides, take what works for you based on your own learning and experience, even if it means taking parts from all sides (to use the current discussion, some people use fundamental analysis and then confirm their ideas using technical analysis.
Technical analysis doesnt necessarily mean you have to go through pages and pages of charts trying to find obscure candlestick patterns, it may be as simple as examining the price history trendlines to determine a good entry point for a stock you have determined to be worth having from your fundamental processes.
I am sure there are as many successful viewpoints as there are successful players!

EDIT: Yes, I have read material by and about W Buffet, and from memory although he suggests that he personally wants nothing to do with the day to day running of the business, Berkshire do have a say in the management of the companies they are involved in. From memory I also think ownership of the company is a very important part of the purchasing decision (rather than just buying a few shares).

 

I think it was WB who said something like, "If Jack Nicholas was the golf pro at the country club you bought, would you tell him how to swing?"
WB only buys into companies that he has 100% confidence in the management, and why would he change it then?

 

I agree - everyone has to come to their own conclusions about which strategy is right for them.

With WB though - he doesn't look to buy a company unless its got great management which will stay in place. Just like with us buying shares - I think the management of a company is very important.
Regards.

 

A quote from yesterday's West Australian: Citigroup has begun coverage of ResMed...
The Citigroup analyst went on about "history of growth" (as if they had been watching it!).

RMD is an ASX100 stock, and Citigroup is one of the largest analysts. That's my point.

(Non-Disclaimer: I don't own RMD).

 

Down side with Paradice small caps is that you need 500 K minimum to invest and ohh ...

they closed for new funds quite a while ago .

Cliff

 

Hi Nigel. Sorry for not answering sooner - been very busy before the end of the financial year with the business, getting properties revalued, finding every tax deduction I can and coaching the U12 boys to top of the ladder of the soccer comp!

I gravitated towards value investing over the years as it basically made the most sense to me and best fits my emotional and risk profiles.

I found trading (both shares and options) an emotional roller-coaster, even though I did reasonably well from a ROI perspective. I was basically betting what I thought everyone else was doing or not doing. Sometimes I got it right, sometimes not. However, what I found (and I know applies to many traders) is that because I was following charts and indicators and gut intuition, I would never bet (sorry...invest) all that much money in a trade (only a few thousand). Therefore, even if the share or option did well, it didn't make that much difference to my net situation.

However, I am more comfortable making much larger investments in good businesses that I perceive as good value. Sometimes this means being very patient and waiting until the share price dips to an acceptable level.

Most people are 'value purchasers'; that is they will carefully consider larger purchases, they will compare prices, they will look at the quality of the item, and often times, once they have identified what they would like they wait for it to go on special (price drop) and then purchase it. This gives them the best result in the long run. Why not apply the same philosophy to investing?

Cheers,

Steve