The Value Investing Process
[Introduction - Part III]
The previous two posts presented the different investment approaches and our views about value investing. This week’s post will take a deeper dive into its investment process.
We understand that many investors label themselves as value investors, though the process differs from person to person. For the context, our approach is focused on the investment process taught for decades by Professor Bruce Greenwald and Mr. Joseph Calandro.
Any comment regarding these gentlemen's views is most welcome. We’d appreciate any discussions in that regard.
The Valuation Approach
Net Present Value (NPV) vs. Value Investing Approach
Comparing AV and EPV
Relating Growth with Value
Comparing AV Against EPV
Let's start by introducing the value investing process. The value investing process has essentially four steps. First is the search. Where do we find good ideas?
How do we actually locate promising investment opportunities? Again, the use of the screens looking for the cheap and ugly will be a critical ingredient of a successful search strategy.
The second step is the heart of the value investing process, which is the valuation. So there are three steps within the valuation.
The assessment of asset values, earnings power values, and the company's franchise value. It's going to be the step to devote most of our time.
The first step will be the review. As you will see, when doing the valuation of a company, we'll focus on the financials. The balance sheet, the income statement, and the cash flow statement.
But, there's a lot of collateral evidence that we can bring to bear to the analysis of the company. So, that's what we do in the third step. We'll also review our personal biases.
We will have a checklist of the typical mistakes we always make. You have a particular soft spot for retail, and you always think that retail companies will be the winner.
You always want it to have in a particular industry. So that's the step where you actually check yourself and your entire process to assess whether you are making some mistake you make repeatedly.
The last step is the risk management step. Is there enough of a marginal safety to invest in that security? The margin of safety will be the fundamental risk management tool of the value investing strategy.
As you have estimated, the security is trading at a deep discount relative to your fundamental value. So the second thing, of course, is the portfolio's construction.
We're not in the camp of efficient market hypothesis, but we don't shine away from having some diversification in our portfolio.
How should you combine the different securities to obtain the winning portfolio you always wanted to have?
Patience is always the right default strategy. If you don't find anything attractive, you can sit out. Don't invest for the sake of investing. Instead, wait for the right opportunity.
The Valuation Approach
Let's describe the main idea. But, first, what is a firm? A firm is a collection of assets - tangible and intangible, and liabilities.
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