2 Min Guide To Value Investing

Imagine you are at a flea market and spot a pair of Sneakers which look like an original pair from Nike. Predictably excited at the opportunity, you pick up the pair and start inspecting to ascertain whether the pair is genuine using your past experience of using Nike merchandise.
On completion of your inspection (Fundamental Analysis 😊) you come to the conclusion that it is indeed a genuine pair of Nike sneakers and brand new.
Now the question is should you buy this pair? Of course, you should, right?
But wait. what’s the asking price?
Case 1: Asking price is US$99 (~INR 6,000)
You do a google search and realize that asking price is same in a Nike or any other branded store.
If you still buy the pair — there are two outcomes possible:
· You are right — Sneakers turn out to be genuine and you end up justifying your price. But you didn’t gain a penny as you would have paid the same amount in a branded store.
· You are wrong — Pair turns out fake and you end up paying US$99 (INR 6,000) for an unbranded sneaker which was worth may be US$9(INR 500). So you end up losing US$90 (INR 5,500)
Now consider another case.
Case 2: Asking price is US$9 (~INR 500)
In this case if you are right and the sneakers turn out to be genuine, you would have gained US$90 as you paid only US$9 for something which was worth US$99
But if you turned out to be wrong, still you wouldn’t have lost any money as a pair of unbranded sneaker would have cost you US$9 anyways
This skewed risk reward is the essence of value investing. Minimal downside if you are wrong and disproportionate upside if you are right. Heads I win, Tails I don’t lose much.
Many people believe that once the fundamental analysis is over and the company is ascertained to have high quality business, the job is done and you just need to buy the stock.
The answer is NO. The second step is to ask — What’s the ASKING PRICE?
The trick is to buy a good company when the price is not reflecting that it’s a good company.
“Value Investing” allows us the “margin of safety” to not lose money even if we are wrong in our analysis provided we diversify our portfolio adequately.
