Value Investing: The Test

[BlueHorseshoe]

Question: If your neighbor came to you and offered to sell you his dollar bills for 40 cents each (because he didn't like paper money), would the offer excite you? You know for a certainty the bills are genuine, and your neighbor is a wealthy eccentric. Or would you rather put your 40 cents into your daytrading or swingtrading account instead??

Is there any reason you wouldn't invest 100% of your funds into buying dollars for 40 cents? What is it??

Here is the relevant quote from WB:

"It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately to people or it doesn't take at all. It's like an inoculation. If it doesn't grab a person right away, I find that you can talk to him for years and show him records, and it doesn't make any difference. They just don't seem able to grasp the concept, simple as it is. A fellow like Rick Guerin, who had no formal education in business, understands immediately the value approach to investing and he's applying it five minutes later. I've never seen anyone who became a gradual convert over a ten-year period to this approach. It doesn't seem to be a matter of IQ or academic training. It's instant recognition, or it is nothing."

 

[yayt]

I'd find it hard to believe anyone wouldn't put 100% of their capital for a risk free gain of 150% over, let's say, 1 year. (.4 * 1.5 = 1)

However, some problems:
1) Where do we find these neighbors?
2) Will the neighbor come up to us with the proposition, or will we have to work very hard to find it?
3) Is any other proposition risk-free?
4) How often will this opportunity arise?

and so on ...

I'm not sure this is such a great analogy but I can see where you were trying to go.

 

[BlueHorseshoe]

Quote from yayt:

I'd find it hard to believe anyone wouldn't put 100% of their capital for a risk free gain of 150% over, let's say, 1 year. (.4 * 1.5 = 1)

However, some problems:
1) Where do we find these neighbors?
2) Will the neighbor come up to us with the proposition, or will we have to work very hard to find it?
3) Is any other proposition risk-free?
4) How often will this opportunity arise?

and so on ...

I'm not sure this is such a great analogy but I can see where you were trying to go.

1. Normally you have to search quite hard for them. In the current market however, they are all over. See my "Buy AM" and "Your Gift: MLP" threads for a couple examples. There are many more in the current market.

2. At this moment many companies are trading at around 50% of their value - you just need to learn to find them. Low P/BV is a good start.

3. Don't understand you point ...

4. Re: listed stocks, these opportunities come in waves - typically in bear markets.

 

[yayt]

True, with 1,2,4.

With #3, we know for sure that a dollar is a dollar, but we can't know for sure that X stock is worth Z dollars, and how low it will go below price Y we paid for it.

 

[BlueHorseshoe]

Quote from yayt:

True, with 1,2,4.

With #3, we know for sure that a dollar is a dollar, but we can't know for sure that X stock is worth Z dollars, and how low it will go below price Y we paid for it.

First, a value investor would suggest that you to stop thinking about stocks, and start thinking about businesses.

Second, if you know a company is worth $100, and you buy it for $50, it should be a good thing that it drops to $30, right? Because then you can buy more, at an even better price.

The rub, as you say, is arriving at the value of a business. There is a lot of nonsense in the market re: how to value a business. (Anyone remember some of the creative valuations Blodget came up with?) But valuing businesses is a skill, like any other. How much time do people on ET spend learning how to value a business?? It might be worth some effort ...

 

[nursebee]

ceteris parabis 100%

 

[oraclewizard77]

See, but what you say is not exactly true.

You are not buying a business unless you buy the entire company.
Instead you own a stock. Unless the stock pays a dividend, the price of the stock is determined by supply and demand of buyers and sellers.

If many buyers believe the stock will be worth more in the near future, they will start bidding up the price of the stock.

They may believe this if the company starts to post better than expected earnings or other factors.

Now lets go back to your example, if you bought say a stock at $ 50/sh and its now worth $ 30/sh. If you believe the company will go back up to $ 50/sh and you have the money to dollar cost down, then yes, I would say its a good idea to invest some more money into it.

Of course many investors right now see their account value go down and when they can not take anymore pain, they sell at or near the bottom. Of course they need to be investing in a good stock that has the chance to go back up. For example, I doubt LEH is going to go back up.

Also, you need to sometimes know when to sell when the stock does go back up. I think this is why an average investor who wants to buy value stocks and does not know the above, should probably just invest in a value mutual fund with a good 10 year track record.

 

[nutmeg]

Imo, in this current economy the wild card is evaluating the customer of your "value buy" AND the viability of continuing in business of any suppliers of your "value buy".

Some of the cos I watch had lower prices back in '03 and the economy was in better shape with money on the sidelines.

Is there any money waiting on the sidelines?