Paradox of value investing

[Cutten]

Quote from u21c3f6:

There is no paradox.

The object is to buy low and sell high. The individual investor decides the %'s that he/she would like to attempt to capture.

This is not a perfect science so you have to allow room for costs, mistakes (losses) and still allow for a "good" rate of return.

Joe.

But you are not operating in a vacuum. You have your cash balance earning 2% in t-bills. You have prospective investments which, at a price, will earn more than 2% + the appropriate risk premium to justify owning the stock.

As soon as the stock falls 1 tick below the level sufficient to generate a return of 2% + the risk premium, surely a value investor must buy? Since the investment will be superior to cash, it would be irrational not to buy.

Then, let's say the stock moves up 2 ticks. The investment is now *inferior* to cash - isn't the rational value investor compelled to sell out and put the money back into cash?

As I said before, having a very large risk premium (e.g. the Graham and Dodd 50% discount) simply lowers the price at which a value investor is logically compelled to buy - and then sell 2 ticks higher.

 

[Cutten]

Quote from tyrant:

What Cutten is saying is that why do you wait until the stock is $40 before buying? Surely you might consider buying it at $75, $70 $65, or $60? Taken to the extreme, why not buy at say $79.50. You have $0.50 profit there! Another difficulty of value investing is : by insisting on a big enough safety margin, you might just miss buying it at all. The stock might go down to 40.50 and proceed to go up to $80.

Yeah - also with the last point, if it was too risky or expensive to be long when it was at $40.01, how can it make sense to stay long at $40.01? Having bought at $40 does not make $40.01 any more or less compelling a valuation. If it was not cheap enough on the way down, how can it be cheap enough on the way up?

 

[Rona1d]

There is no correct way of finding the actual value of the company. THere are to many unknowns. THerefore, each persons evaluation in a company might be different than yours.

 

[FerdinandAlx]

Quote from Cutten:

Yeah - also with the last point, if it was too risky or expensive to be long when it was at $40.01, how can it make sense to stay long at $40.01? Having bought at $40 does not make $40.01 any more or less compelling a valuation. If it was not cheap enough on the way down, how can it be cheap enough on the way up?

Equity builds up as the shareprice increases, maintaining the margin of safety. Stop trying to turn this into a financial version of Zeno's paradox.

 

[Rona1d]

And so, in ur example: YOU found that the value of the stock was 41$, and let's say that it was selling for 40$. So you buy it, and so ur question was if it goes up to 41$, what makes it logical to buy. THe answer is that other people might have different calculations of what the value of the stock really is, one person might think that the stock is really worth 45$ per share, and so he would buy your share of 41$ because for his calculations, it is a good price. The point is, calculating the value of the stock is very complicating, and many unknown factors(such as discount rate, expected growth in future etc.)

Perhaps you should learn more about value investing, because it is obvious that you know little to none..

 

[u21c3f6]

Quote from Cutten:

But you are not operating in a vacuum. You have your cash balance earning 2% in t-bills. You have prospective investments which, at a price, will earn more than 2% + the appropriate risk premium to justify owning the stock.

As soon as the stock falls 1 tick below the level sufficient to generate a return of 2% + the risk premium, surely a value investor must buy? Since the investment will be superior to cash, it would be irrational not to buy.

Then, let's say the stock moves up 2 ticks. The investment is now *inferior* to cash - isn't the rational value investor compelled to sell out and put the money back into cash?

As I said before, having a very large risk premium (e.g. the Graham and Dodd 50% discount) simply lowers the price at which a value investor is logically compelled to buy - and then sell 2 ticks higher.

Not sure where the disconnect is.

In the given example, the amount of discount required is 50% to cover return, risk premium, expenses etc. therefore when a stock which I value at $80 (your value may and obviously the market's value at this time differs) is trading for $40, I buy.

Now if the stock goes up to $41, that is not $1 above fair value to me because I calculated my fair value to be $80. In addition, I need to sell at $80 if I am to cover my return, risk premium, expenses and losses incurred using the very same valuation process for other trades. They don't all win.

 

[nutmeg]

What I claimed is that if you did not think the stock was worth owning at $79 in the first place, why do you suddenly think it is worth owning at $79 now?

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Perhaps they are a stubborn lot.

They run their numbers and arrive at a price they wish to buy known as "my price". Now if "my price" is 40 and I buy it at 40 then the prices moves to 41 they still own it because it was not worth buying at 41 but is worth owning at 41 because I purchased it at "my price".

On the flip side. I followed a work up on PIR when it was about 17(?) the arguement was "my price" is $11. Well you can have it for 11. Think that was a Buffet pick at the time not sure he even owns it anymore.

 

[Cutten]

Quote from Rona1d:

And so, in ur example: YOU found that the value of the stock was 41$, and let's say that it was selling for 40$. So you buy it, and so ur question was if it goes up to 41$, what makes it logical to buy. THe answer is that other people might have different calculations of what the value of the stock really is, one person might think that the stock is really worth 45$ per share, and so he would buy your share of 41$ because for his calculations, it is a good price. The point is, calculating the value of the stock is very complicating, and many unknown factors(such as discount rate, expected growth in future etc.)

Perhaps you should learn more about value investing, because it is obvious that you know little to none..

Look, from your posts it's obvious you simply don't get the point I was making in this thread. In every single post it's clear you just don't understand what I'm saying. You repeatedly make major misinterpretations of my position - even accusing me of beliefs that I *went out of my way* to pre-emptively deny in my earlier posts. From your spelling and grammar, along with the frequent misunderstandings (that no one else on this thread has made), I am thinking perhaps English is not your first language?

To address your points:

i) I've already said in my earlier post that I'm making an assumption that the hypothetical investor has perfect analytical ability and knows the true intrinsic value of the stock. Thus there is NO dispute over what the value is.

ii) Why would other people's opinion of value affect the investors buy and sell decisions? His decisions will be based on his valuation not others.

iii) The "complicating" factors are not an issue, see point i)

Your parting insult was a cheap shot and completely uncalled for, since I never said anything personally insulting to you. If you have any manners, you ought to apologize.

 

[Cutten]

Quote from u21c3f6:

Not sure where the disconnect is.

In the given example, the amount of discount required is 50% to cover return, risk premium, expenses etc. therefore when a stock which I value at $80 (your value may and obviously the market's value at this time differs) is trading for $40, I buy.

Now if the stock goes up to $41, that is not $1 above fair value to me because I calculated my fair value to be $80. In addition, I need to sell at $80 if I am to cover my return, risk premium, expenses and losses incurred using the very same valuation process for other trades. They don't all win.

Sure, but the point is, if $41 is way below fair value, why not buy there in the first place? How can you turn your nose up at $41, then suddenly you love the stock at $79?

If $40 was needed to cover the risk - well, $79 sure as hell covers no risk at all, it's practically double the price and only $1 below fair value.

 

[Cutten]

Quote from nutmeg:

What I claimed is that if you did not think the stock was worth owning at $79 in the first place, why do you suddenly think it is worth owning at $79 now?

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Perhaps they are a stubborn lot.

They run their numbers and arrive at a price they wish to buy known as "my price". Now if "my price" is 40 and I buy it at 40 then the prices moves to 41 they still own it because it was not worth buying at 41 but is worth owning at 41 because I purchased it at "my price".

On the flip side. I followed a work up on PIR when it was about 17(?) the arguement was "my price" is $11. Well you can have it for 11. Think that was a Buffet pick at the time not sure he even owns it anymore.

That's quite possible, but I hope we can all agree that there is no rationale or logic behind this line of thinking. You might as well say "I own it because I feel like it". I'm trying to get to the rationale for having such a huge gap between the price they are prepared to own it on the way down, and the price they are prepared to own it on the way up. So far no one has given a convincing explanation.