Education

Top Lessons Learned from being a Value Investor Part 1

Fundamental Analysis

Within the investing space, there are various forms of investing or trading. Some investors are very short-term an in fact traders. These can be traders who focus on charts and do technical analysis. There are some traders that are day-traders that only trade stocks during a single day closing their positions before the end of trading each day. These investors are in essence called speculators. On the other side of the spectrum, you have long-term investors such as Warren Buffet, Benjamin Grantham or Seth Klarman that are considered “Value Investors”. Value Investors focus on more on the intrinsic value of the company the most important thing. They focus less on short-term price movements or other factors that are not related to the company. We have previously covered one facet of value investing, with the run-through of the fundamental approach of DCF valuation.

As most professional investors often have different buckets of how they invest. For example have 45% of their funds focused on value-investing, another 45% on more trading oriented investing and 10% on more speculative long-shots. We will go through the main lessons we have learned over the years using a value investing approach to investing capital.

Having Discipline

Value investing per-se is not an advanced form of investing. One does not need to know advanced mathematics or super deep knowledge of various facets of finance. Most value investors are not super advanced analytical savants who create complex computer models to find investing opportunities. Value investors’ most important probably most difficult trait is to have discipline. When looking at an investment on a long-term horizon, one needs patience, not rushing to judgements or only investing when the right opportunity comes along. This might seem straightforward and easy advice, but being able to sit on the sidelines waiting for the right opportunity, when a potential investment hits right levels is difficult. Inherently investors want to “do something” and put money to work.

Being Contrarian

By definition, value investors are almost all contrarian, differentiating from the crowd. The way one as investors find the best bargains is the look at parts of markets, sectors that are completely out of favour with the general investing crowd. A value investor often challenges the conventional wisdom on the investing market and goes against the prevailing “hot themes”. Again this means that potentially over long periods of times as a value investor one underperforms the general market. A value investor knows that as the share price of a company rises, it becomes more risky not less.  For example value, investors had an abysmal relative performance during the IT bubble of the early 2000s. Eventually, they did receive vindication as the IT bubble crashed and value-stocks that were so much out of favour at that time, and share prices declined massively outperformed general IT sector.

The Markets are not always Right

As a value investor is it important not be beholden to the Market and its movements. In other words to take a step back an fully trusting one’s own analysis and not blindly following the market let say in situations where markets drop substantially. In the end, the market is just the collective actions of millions buyers and sellers, who themselves are not always motivated by investment fundamentals. Learning this lesson is fairly difficult. Naturally, if an investment one has dropped massively, one just wants to limit one’s losses and sell right away. Instead of believing and trusting in one’s own analysis and knowing these massive price movements are short-term in their nature.

Share Price Vs Business Reality and Value

One of the most important lessons’ one learns as an investor is not to conflate share price of a company with the business relative. Just because the share price of a stock rallies does not mean that the underlying business is doing great, or vice-versa. A share price increase might not fully justify the same increase in the underlying value, or for that matter the opposite of share price decline with the corresponding reduction of value. Even though at least on short-term perspective this might be true, it often leads to over-reaction over a longer term. Of course, in general, especially in trending markets, buying beget buying and selling begets selling, as a value investor one most realize these movements might not reflect the underlying value of the asset.

On the same principle, as a value investor one must look at the share price in relation to the value, and not just the share price when making decisions. In other words, large share-price movements that lead to deviations from the underlying value creates massive investment opportunities for a value investor, whilst just blindly following the share price of a company as guidance for making an investment (something short-term traders and speculators do) is a recipe for disaster for value investors.  A key pillar of value investing is to do one homework and due-diligence on the intrinsic value and being prepared when the share-price deviates from this value and make an investment.

Process, Process, Process, Not letting Emotions play a role  

Being a value investor (for that matter any other type of investor) it is important not letting one’s emotions take over. The best to achieve this is to have a sound and rock-solid intellectual framework and investment process. Following one’s process and staying true and disciplined to this process minimizes the likelihood that any potential emotion affects one’s investment decisions.

Conclusion

These are the most fundamental lessons that come value investing. They are very straight-forward and rational, but as any long-term and professional investor knows, it is easy to know of the rules and lessons and much more difficult to consistently follow these rules and frameworks. What I have learned over the years as the more seasoned investor I have become, when religiously follow these rules and lessons I deliver consistently good results. Often, when I have had a good investing run, I used to lose my discipline and get a bit reckless not following my own rules, resulting not too far after underperformance.

We will continue going through the additional important lessons and rules for value investing in a follow-up post.