Paradox of value investing

Hi Cutten:

I first read the "Intelligent Investor" back in 1975 I think it was. As you probably know, we had just had a major bear market that had taken the Dow to 550. There were large numbers of stocks that were "value" type investments.

I used to buy stocks that were under what we called the "net current liquidation value", which was defined as the current asset less ALL debt, both current debt and long term debt. If we could buy that type of stock under that value, we thought we had a good buy. Clearly, if you were able to buy all the stock at such a value, you could presumably liquidate the remaining assets of the company, as your profit.

In those days, Value Line Investment survey had a list of these stocks. It was a very large list.

I see the seeming contradiction that you speak of. However, using your example, if you bought a stock at 40, that you thought had a fair value of 80, I don't see why that would mean you would have to sell at 41. Once you have bought at 40, your discount to fair value doesn't disappear just because the stock trades to 41. Your cost basis is still 40. You might not be willing to purchase more stock. But there is no reason to sell either. In fact, if you felt the fair value was 80, you might be willing to hold the stock until it hit fair value. Warren Buffet though, buys stocks that he may never sell. His discount remains intact as long as the company progresses. His discount does not change regardless of what the market may do. That's why he has said they could shut the market down and it would not disturb him.

Back to my original thought on buying stocks at a discount to their net current liquidation value. One of the stocks that I discovered on that list was Diebold. At the time, it was a manufacturer of safes and bank windows. Trading around 10, with a liquidation value of about 14 as I recall. What I liked about this company was that they were just entering the ATM business. However, their primary competition was IBM, and no one thought DBD could beat IBM. But at 10, the stock was very cheap, and I thought the ATM business might be a plus for them.

As it turned out, after holding it for a while, the stock started up, went to 20, where I unloaded. It then went to 150 as they clobbered IBM in the new ATM business. LOL. That should have taught me something...but unfortunately, it was a lesson I was to repeat many times, not holding long enough to realize the potential. DBD still trades today...and while I have lost track, I'm guessing my adjusted cost basis in todays stock may be under 10 cents per share.....it trades in the 30's now. Warren Buffet might still be holding a stock like that.

Anyway, I'd say the selling criteria is distinguished from the buy criteria for most value investors. But if there is a fault for value investors, it is that they sell too soon.

OldTrader
 
"Contrary to popular belief, we find Berkshire Hathaway invests primarily in large-cap growth rather than "value" stocks."


Abstract:
We analyze Berkshire Hathaway's equity portfolio over the 1976 to 2006 period and explore potential explanations for its superior performance. Contrary to popular belief, we find Berkshire Hathaway invests primarily in large-cap growth rather than "value" stocks. Over the period the portfolio beat the benchmarks in 27 out of 31 years, on average exceeding the S&P 500 Index by 11.14%, the value-weighted index of all stocks by 10.92%, and a Fama and French characteristic-based portfolio by 8.56% per year. Although beating the market in all but four years can statistically happen due to chance, incorporating the magnitude by which the portfolio beats the market makes a luck explanation extremely unlikely even after taking into account ex-post selection bias. We find that Berkshire Hathaway's portfolio is concentrated in relatively few stocks with the top five holdings averaging 73% of the portfolio value. While increased volatility is normally associated with higher concentration we show the volatility of the portfolio is driven by large positive returns and not downside risk. The market appears to under-react to the news of a Berkshire Hathaway stock investment since a hypothetical portfolio that mimics the investments at the beginning of the following month after they are publicly disclosed also earns significantly positive abnormal returns of 10.75% over the S&P 500 Index. Our evidence suggests the Berkshire Hathaway triumvirates of Warren Buffett, Charles Munger, and Lou Simpson posses' investment skill unlikely to be explained by Efficient Market Theory.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=806246#PaperDownload
 
Perhaps you should learn what value investing before you contradict the methods of Benjamin Graham. Because obviosely for you saying that value investing is irrational then you are obviosely smarter then 30 years of geniuses

How do value investors rationally own stock? According to their methodology, each stock can be valued at a certain price. As an example, let's say stock X is trading at $100, and a value investor comes up with fair value at $80. At what point is it rational to buy? Surely at $79.99 it is now "value" and should be bought, rather than holding cash or index investments? I do not see how it can be rational to wait for lower prices - if the stock is cheaper than the alternatives, a value investor is compelled by their methodology to own it. There now arises the problem - if fair value is $80, how can the investor hold it above $80? Logically the investor is compelled to sell at $80.01.

Graham and Dodd tried to come up with a rationale for waiting for bigger discounts to true value. Due to risk, uncertainty, illiquidity etc, they said an investor should wait for a margin of safety of 50%. However, they then have the same problem, it's just that the price is different. In the case of stock X, their margin of safety would put a buy point at $40 - half the intrinsic value. So they buy at a huge discount. The problem is, as soon as it goes back to $40.01 or higher, they again have to sell to be logically consistent. If a 50% margin of safety is required to own the stock, then that means 49.99% is not enough. If they would not buy at $40.01 on the way down, then how can they own stock at $40.01 on the way up? Assuming the intrinsic value does not change, the rational value investor can only take 1-2 ticks out of any investment.

To hold on for longer than two ticks, the calculated intrinsic value must increase each day by more than the stock price appreciation - a rather far-fetched assumption.

Note that growth stock investors do not have this problem as much, because they are typically buying and holding stocks that are going up to new highs. However, it faces ALL dip-buying investors who do not claim to be able to predict future price. How can you not own something at price X, buy at X minus 1, then hold at X +1? If it is cheap at X+1, then you should have bought at X+1 or X on the way down, shouldn't you?

Can someone point out the flaw in my logic? Or is all valuation-based investing completely irrational?

Traders do not face this problem, because they are saying "price is headed higher". Yet almost all investors claim they can't predict price, only valuation. Yet they willingly refuse to own stock when it is undervalued, then after purchase, they hold it when it is at a higher price than before when they refused to own it. Makes no sense to me.

A secondary paradox comes after exit. If you sell a stock at $100, that means you thought it was a buy at $99.99. But if you think that, then doesn't it become a buy again at $99.99 if it falls back a tick? Thus, all value investors should re-enter their positions as soon as they fall 1 cent.

N.B. all this assumes no minute by minute change in the valuation. Obviously sometimes news comes out which causes a large shift in value, and then selling and not re-entering makes sense, as does buying and not immediately selling 1-2 cents higher. [/QUOTE]
 
generally the reason that a stock is being traded at higher than it's book value is because it has strong prospects and chances are that in the future it will grow
 
lol this is basic investing

book value- The value at which an asset is carried on a balance sheet. In other words, the cost of an asset minus accumulated depreciation.
 
Scratch my post. I was just making a joke on OSTK. Trading over book value? Very subjective re future prospect and growth.
 
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