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The business of value investing – Six essential elements to buying companies like Warren Buffett- Charlie Tian 2009
https://bbs.pinggu.org/thread-695143-1-1.html (Page 187-195)
Growing intrinsic value provides undervaluation
Conservative Tests of Safety a Must
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It cannot be stressed enough that discovering a business with future growth prospects selling at a reasonable price is only the first step in the investment process. Never, ever invest simply because such conditions exist. But if you do find them, you can go on to determine whether the business can sustain this growth for a period of years and whether this growth will require high levels of capital expenditures. As the company grows, so will intrinsic value and, ultimately, so will the market value. Even when sitting still, however, the investors’ work is not complete. On the contrary, once an investment is made, the work becomes more painstaking. Determining that a security is undervalued and suitable for purchase is one thing; ensuring that the business remains an attractive investment is quite another. At a minimum, investors should check on the status of the investment quarterly along with the required regulatory filings issued by the business to the Securities and Exchange Commission. The purpose of these regular check-ups is to be on the lookout for any significant signs that the overall fundamental condition of the business is deteriorating. Making such a determination is both part art and science. Generally, quarterly performance should be of no significant concern if the investment made truly satisfied the conditions of an undervalued one with a satisfactory margin of safety. Of course, careful detail and analysis should be given to the annual report, which lays out the results of the year and the future prospects of the company. In addition, investors should be well aware of the industry and competitive forces that might affect the investment. Doing all of this analysis will significantly increase the likelihood that the investment is disposed of when it reaches intrinsic value, which should result in a gain if the security was purchased at significantly below the intrinsic value. If not, then again, investors face a good possibility that the investment will be sold at a minimal loss.
Most of us are not old enough to recall the pain of the Great Depression, and some may not even remember the bear market of the early 1970s. Unfortunately, many were exposed to the severe market decline in 2008 as a result of decades of excessive borrowing in the United States. 5 The year 2008 managed to eclipse the 1973 bear in terms of total loss for a year: 38.5 percent for the S&P 500 index. Not since 1931, at the height of the Great Depression, has a market lost so much in a single year. The severe economic recession that took hold in 2008 highlights the need for conservative tests for safety when analysing investments. Going a step further, 2008 illustrated the need for investors to analyze companies under the severest of operating conditions. No longer was it satisfactory to assess future intrinsic values based on earning results of the past several years.
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In times many companies likely will be earning record profits as severe economic conditions force out weaker, less efficient competitors. The market collapse of 2008 simply reinforces the absolute requirement for a margin of safety that can pass the test during prolonged periods of economic contraction. In the case of DryShips, it was absolutely necessary to re-evaluate the carrying costs of the assets in light of reduced valuations for the vessels. Simply assigning the stated book value of 49 a share was not satisfactory in order to assign a conservative book value for the company. In the case of Johnson & Johnson, over 100 years of profitability during various economic conditions was in itself a satisfactory condition that the company was still a suitable investment.
Investment in stocks should be made with a long - term orientation. In the short run, market prices are affected by the votes of the market participants. In the long run, stock prices will catch up with the fundamentals of the business. Along with reduced trading mistakes, a patient investment approach minimizes transaction costs. The level of cash in a portfolio should be affected by the availability of bargain investments. Some of the markets’ greatest benefits— liquidity and establishment of prices can also be a source of great loss to investors who fall prey to the unnecessary noise they often create. General undervalued investments arise from two situations: market prices below private sale value or buying growth businesses at reasonable prices. Both situations allow for an investment to be made at prices sufficiently below intrinsic value.
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