“Price is what you pay. Value is what you get.” – Warren Buffett
Value investing does not mean buying cheap stocks. Rather, it refers to buying shares in a business that is priced below what we determine to be its actual worth. The primary consideration is evaluating if a stock is overpriced, fairly priced or under priced relative to its future income stream and/or net asset value. As example, a mid-cap company that is showing rapid growth and increasing earnings on progressive capital may be a better value than a blue-chip stock that would appear ‘better valued’ based on conventional PE and price/book ratios. The better valued stock may be the one that is ‘more expensive’ by mainstream consensus.
“While some might mistakenly consider value investing a mechanical tool for identifying bargains, it is actually a comprehensive investment philosophy that emphasizes the need to perform in-depth fundamental analysis, pursue long term investment results, limit risk, and resist crowd psychology.” – Seth Klarman
Quantitative Analysis Parameters
1. Companies with an earnings yield (EPS/stock price) exceeding the yield of long term government bonds from the average of a designated basket of countries;
2. Stocks trading lower than their net asset value, with prices discounted from short term issues like weak quarterly earnings or negative press, while the company maintains a healthy balance sheet and strong management;
3. Stocks trading below fair market value with financials that are better than their competitors;
4. Stocks we anticipate showing a significant improvement from an existing or upcoming material change such as the sale of a losing division, a management or governance shift, or a change in industry dynamics.
Qualitative analysis uses subjective judgment pertaining to non-measurable information such as management, labor relations, industry and economic cycles. Our analysts look at a company’s ownership and governance, management and incentive structures, employee turnover, R&D, competitive strengths and weaknesses, and accounting policies, among other things. We look for instances where a qualitative issue, such as the implementation of a new growth strategy, may not yet be reflected in the price of the stock.
We then delve deeper, looking for divisions that might be profitably spun off or divisions that are underperforming and dampening the overall financials. We compare it to other companies in the same industry with a similar outlook to see if the market is pricing them the same or differently, for no discernible reason. We also look to see where there are inefficiencies in the global pricing of corporate assets. Understanding differences in accounting and valuation can help to uncover very attractive opportunities in different markets.
Stocks vs Bonds
“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” – Warren Buffett
One of the first questions most new clients ask is about the ideal asset mix. The ideal asset mix for each portfolio will vary, depending on factors including an investor?s age, financial situation, career and risk tolerance. Establishing the asset mix for a client portfolio is as much an art as a science, and is one of the strongest determinants of projected returns. Most portfolios should include a mix of both equity and fixed income; the question is in what ratio. Another important question is whether the income portion ought to include government bonds, corporate, preferred stocks or a mix.
Portfolios that are fully invested in equity will yield the highest returns over the long term but are not appropriate for everyone. It?s important to take into account issues like risk tolerance and income needs. Including bonds in a balanced portfolio will reduce overall volatility compared to portfolios fully invested in equities. Rock Trading Inc advisors are skilled at evaluating the ideal mix for each individual.
Fixed Income Investments
“Experience teaches that the time to buy preferred stocks is when their price is unduly depressed by temporary adversity… in other words, they should be bought of a bargain basis or not at all.” – Benjamin Graham
TWO DETERMINENTS OF VALUE IN FIXED INCOME ASSETS:
1. ANTICIPATING INTEREST RATES: When interest rates rise, fixed income investment prices fall. When interest rates fall, fixed income investments rise. If we assess that interest rates are about to rise, we may shorten bond durations to minimize capital losses. Conversely, when interest rates look about to fall, we maintain longer bond durations for capital appreciation.
2. LOOKING FOR BONDS THAT ARE NOT PRICED EFFICIENTLY:Just like with common stock, preferred shares and corporate bonds may be priced inefficiently, usually due to underlying qualitative issues. Preferred shares or corporate bonds may be depressed due to short term bad news in a company that we deem to be fundamentally strong, which presents a buying opportunity.