Best Value Investing Blogs, Tips and Articles

I have been asked a few times why I do not invest in commodities. As a value investor, it is really hard to wrap my mind around the notion that commodities might be considered an investment. Here is why.

Commodities have no intrinsic value.

They have price. But the price is not the same as the intrinsic value.

Value investing is a process that aims to deliver outstanding long term returns. However, this should not be confused with the notion that value investors tend to buy and hold stocks for the long term. Long term investing indicates a consistent adherence to a strategy over a period of time – it does not mean you buy and continue to hold a stock regardless of its merit. Buy and hold strategy ignores valuations over the holding period.

Often you might come across stock warrants and you might have wondered what does it mean. Even if you are not interested in buying the warrants, it is important to know if the company that you are interested in buying the stock in also has outstanding warrants, as the warrants can have disproportionate effect on the returns you may be able to realize from the stock itself. To understand why this is the case, it is critical to understand what is a stock warrant and how it works. There are similarities between warrants and options but they also differ in some key respects.

For most investors who have grown up on the diet of high stock beta = high risk, this statement will come as a surprise. Beta means nothing for a stock. And beta explains nothing about the investment merits of a stock.

Investment risk rarely matches the risk perception in a security. Let’s see why.

Held long enough, the price of a security approximates its value.

Buying overvalued stocks in most cases deliver lackluster performance as the value struggles to catch up with the price. The price may decline, or if the business is growing value at a rapid pace, than perhaps there may be some price appreciation. Regardless, there is a better way to invest with less risk and more rewards
Buying undervalued stocks, in most cases deliver outstanding performance over time as the price rises to catch up with the value – as long as the business continues to create value over time

Investors are constantly reminded that the markets are efficient and there is no use trying to beat the market as it cannot be done on a consistent basis. In fact, we are told, that over 70% of the mutual funds fail to beat the market, presenting this as an evidence to somehow imply, in some convoluted logic, that we are better off handing over our money to the same mutual funds and invest passively, rather than take control of our own portfolio. I find this argument even more vacuous, considering that the best investors and stock pickers, who also happen to manage significant sums of money, do not usually run mutual funds.

Classic value investing focuses on balance sheet with an understanding that in most industries, earnings power has no value as over time, competition and threats of substitution erodes any competitive advantage the company may possess. While this may be true, income statement should never be ignored. There are a few situations where they become critical to determine soundness of an investment.

Asset diversification, as it is practiced today, is a crutch.
From financial advisors, mutual fund industry, media, personal finance bloggers, and every one in between, there is a consensus that diversification is essential for the best investment portfolio you can construct. Nothing can be further than the truth. The fact is, with the state of the investment industry today, your portfolio is very likely to be over diversified than under diversified. After a certain point, over diversification does not add any benefits to the portfolio, but it does take away from the potential rewards.

Every business valuation should start with a balance sheet analysis. It is easy to get lost in numbers and a range of what if scenarios when evaluating stocks for investment. While the financial statements may be standardized for GAAP, each line item in these statements have a history behind it that is unique to the company in question. Sometimes one needs to go beyond the numbers to understand the business to determine if the stock in the company under consideration is worthy of investment. Investors often get bogged down in projections and estimates. However a balance sheet is real and known and presents a better indicator of value with data that is more likely to give us a conservative estimate of the value.

The way to identify an undervalued stock is to empirically determine an intrinsic value of the stock that serves as a benchmark against which the stock price can be compared. If this intrinsic value is higher than the stock price in the market today, than the stock can be considered undervalued and vice versa. Over the years, many methods of establishing this valuation benchmarks have been devised and are in use today. Book Value of a stock is one such method.

To know if the price you are paying for a stock is fair, you need to have a good estimate of the value of the underlying business, or the intrinsic value that each share represents. While the stock price fluctuates based on the demand and supply of the shares in the secondary market, the business value only changes when the business conditions change. Over time, the intrinsic value and the stock price tend to correlate, in the short term there might be discrepancies large enough that an intrepid investor can exploit for profit. Learning about intrinsic value will help you value stocks to buy.