Value is an eclectic concept; it exists in many forms but it always carries one common theme. The theme involves buying something for substantially less than its intrinsic worth. But how is it possible to consistently purchase equities which are trading substantially below their intrinsic value when competing investors are privy to same set of information?
The answer is deceptively simple: Never allow the price or the price movement of a stock to influence your buying decision. In other words, always assume that the market is wrong until you can conclude beyond a shadow of a doubt that the market is correct. That simple statement explains the reason that individuals who are contrarian by nature are generally more successful when it comes to investing.
Please do not misinterpret the above statement; one can go broke just as quickly by blindly purchasing equities that are trading near their lows just as they can by chasing momentum. That said, Walter Schloss did not hunt for leads by examining stocks at their 52-week highs; instead he scoured the list of 52-week lows to find potential values. Additionally, Schloss did not require that the stocks he purchased were currently making money so long as their balance sheets contained a valuable set of assets which were trading well under their intrinsic value. Indeed, the fact that they were currently slumping from an earnings perspective was generally the reason that the stocks had dropped precipitously. The key question being, is the earnings decline terminal or merely a temporary setback?
The average investor automatically assumes that the market is correct and quickly adopts a simplistic rationale which justifies the drop. Turn into an episode of "Mad Money" and you can witness that practice on a daily basis. The same criterion is used if the stock is appreciating; the average investor invariably assumes that the market is correct and immediately rationalizes a consensus opinion. Thus predicting the short term price movement of a stock becomes the focal point for most investors rather than attempting to assess the underlying value of the equity.
Time after time Warren Buffett has driven home the point that he does not attempt to predict movements in the general market or in individual stocks. Instead, Mr. Buffett attempts to "price the stock." In other words, he calculates an estimation of the intrinsic value of a stock then he compares his "estimation" to the current market price of the stock. If his estimated price exceeds the current market price by a sufficient amount, then he buys the stock without regard to its short term movement. More often than not the process results in purchasing stocks which are much closer to their 52-week lows than their 52-week highs.
An example is in order. Amazon (AMZN, Financial), a daily tout on Jim Cramer's show, harkens back to the dot-com era over a decade ago when anything associated with the Internet was blatantly overpriced. Enter Amazon with a trailing P/E ratio of 100, operating margins of 3.14%, and a bloated trailing EBIDTA/EV multiple of 50. Cramer insists that the company is a BUY BUY BUY because it it growing, it utilizes a business model which is evolving while cutting out numerous brick and mortar businesses. But mainly he likes it because of its upward momentum. Everything else is just a sideshow and a justification for the upward momentum.
The ticker knows something and Cramer knows that Amazon is going up therefore the company must be bought. The concept of attempting to price the intrinsic value of the equity or assess a suitable margin of safety never enters into the picture; instead the success of any investment is judged by the short-term price movement of the stock. The crux of the show almost entirely involves the host speculating on the short-term movements of various stocks, then adding his "professional insight" which rationalizes the recent movement.
The absurdity and utter futility of purchasing stocks which are trading near their 52-week highs with sky-high valuations becomes masked when one becomes focused on short-term price movements. It is exactly that misguided focus which causes most investors to underperform the industry averages on a regular basis. Yet the positive feelings which most individuals encounter in the short term when they "invest with the trend" seems to outweigh the stark reality of their yearly underperformance.
Every successful value investor knows that it is impossible to make money everyday; indeed it is unreasonable to expect that one can show a profit every year. In fact almost every successful value investor has an occasional year when they underperform the general indices. In the face of such a reality, most investors simply cannot accept the short-term movements which go against them, and they eventually succumb to the Amazons of the world. Many of these investors are fully aware of the importance of patience; however, what they know and how they act are frequently incongruent.
Recap
1) Value investing is the act of buying a stock for substantially less than its intrinsic value.
2) Value investors must never allow short-term price movements to influence their decisions.
3) Successful value investors must assume that the market is wrong until it can be proven correct beyond a shadow of a doubt.
4) Not all stocks trading near their 52-week lows are buy candidates but the list provides a good source of leads.
5) A stock may be a buy candidate even if it is currently losing money so long as the situation can be judged to be temporary in nature.
6) According to Buffett, an investor's prime objective should be to "price" a stock while ignoring its short-term price fluctuations.
7) Value investors must understand that it is impossible to make money every day and accept the fact that they may underperform the market in certain years.
8) Patience must be maintained even when shortterm price fluctuations consistently move against the value investor.
The answer is deceptively simple: Never allow the price or the price movement of a stock to influence your buying decision. In other words, always assume that the market is wrong until you can conclude beyond a shadow of a doubt that the market is correct. That simple statement explains the reason that individuals who are contrarian by nature are generally more successful when it comes to investing.
Please do not misinterpret the above statement; one can go broke just as quickly by blindly purchasing equities that are trading near their lows just as they can by chasing momentum. That said, Walter Schloss did not hunt for leads by examining stocks at their 52-week highs; instead he scoured the list of 52-week lows to find potential values. Additionally, Schloss did not require that the stocks he purchased were currently making money so long as their balance sheets contained a valuable set of assets which were trading well under their intrinsic value. Indeed, the fact that they were currently slumping from an earnings perspective was generally the reason that the stocks had dropped precipitously. The key question being, is the earnings decline terminal or merely a temporary setback?
The average investor automatically assumes that the market is correct and quickly adopts a simplistic rationale which justifies the drop. Turn into an episode of "Mad Money" and you can witness that practice on a daily basis. The same criterion is used if the stock is appreciating; the average investor invariably assumes that the market is correct and immediately rationalizes a consensus opinion. Thus predicting the short term price movement of a stock becomes the focal point for most investors rather than attempting to assess the underlying value of the equity.
Time after time Warren Buffett has driven home the point that he does not attempt to predict movements in the general market or in individual stocks. Instead, Mr. Buffett attempts to "price the stock." In other words, he calculates an estimation of the intrinsic value of a stock then he compares his "estimation" to the current market price of the stock. If his estimated price exceeds the current market price by a sufficient amount, then he buys the stock without regard to its short term movement. More often than not the process results in purchasing stocks which are much closer to their 52-week lows than their 52-week highs.
An example is in order. Amazon (AMZN, Financial), a daily tout on Jim Cramer's show, harkens back to the dot-com era over a decade ago when anything associated with the Internet was blatantly overpriced. Enter Amazon with a trailing P/E ratio of 100, operating margins of 3.14%, and a bloated trailing EBIDTA/EV multiple of 50. Cramer insists that the company is a BUY BUY BUY because it it growing, it utilizes a business model which is evolving while cutting out numerous brick and mortar businesses. But mainly he likes it because of its upward momentum. Everything else is just a sideshow and a justification for the upward momentum.
The ticker knows something and Cramer knows that Amazon is going up therefore the company must be bought. The concept of attempting to price the intrinsic value of the equity or assess a suitable margin of safety never enters into the picture; instead the success of any investment is judged by the short-term price movement of the stock. The crux of the show almost entirely involves the host speculating on the short-term movements of various stocks, then adding his "professional insight" which rationalizes the recent movement.
The absurdity and utter futility of purchasing stocks which are trading near their 52-week highs with sky-high valuations becomes masked when one becomes focused on short-term price movements. It is exactly that misguided focus which causes most investors to underperform the industry averages on a regular basis. Yet the positive feelings which most individuals encounter in the short term when they "invest with the trend" seems to outweigh the stark reality of their yearly underperformance.
Every successful value investor knows that it is impossible to make money everyday; indeed it is unreasonable to expect that one can show a profit every year. In fact almost every successful value investor has an occasional year when they underperform the general indices. In the face of such a reality, most investors simply cannot accept the short-term movements which go against them, and they eventually succumb to the Amazons of the world. Many of these investors are fully aware of the importance of patience; however, what they know and how they act are frequently incongruent.
Recap
1) Value investing is the act of buying a stock for substantially less than its intrinsic value.
2) Value investors must never allow short-term price movements to influence their decisions.
3) Successful value investors must assume that the market is wrong until it can be proven correct beyond a shadow of a doubt.
4) Not all stocks trading near their 52-week lows are buy candidates but the list provides a good source of leads.
5) A stock may be a buy candidate even if it is currently losing money so long as the situation can be judged to be temporary in nature.
6) According to Buffett, an investor's prime objective should be to "price" a stock while ignoring its short-term price fluctuations.
7) Value investors must understand that it is impossible to make money every day and accept the fact that they may underperform the market in certain years.
8) Patience must be maintained even when shortterm price fluctuations consistently move against the value investor.
