Beyond value investing: How you can be off the mark and still have it pay off
How much you truly believe in something is manifested by how much you’re truly willing to risk for it — Nassim Taleb
You’ve had this stock on your mind for a few weeks and the moment of truth has come.
Buy, wait or pass?
This is the choice every investor in securities, such as stocks, has to face. How we all get through this as investors may vary, but there comes a time when you have to put some skin in the game.
When a friend of yours uploads your new beach-body photo on Facebook and the platform suggests to tag your face, it is…www.datadriveninvestor.com
For years I had aspired to be a value investor. But something felt off about how I went about this specific stock analysis.
It sure didn’t feel like Warren Buffett would approve. #wwwd?
In this post, I’ll be sharing my reflections on the marks of a true value investor. And how I’m slowly adopting a close cousin of that approach.
5 Signs That You are Speculating and Not Investing
It’s important to address this upfront because it’s easy to mistake a speculator for an investor.
Here are some signs that you are dealing with a speculator
- Emotions drive opinions or decisions
- Less focus on the present and an obsession with predicting the future
- Rational is not based on fundamental financial analysis. Instead on the anticipation of an upside
- Not enough concern is given to protecting principal
- Trying to time the market
Many so-called experts fit this like a hand in the glove. If you see any of these signs in a pundit, replace everything they say with blah blah blah.
Per a Charlie Munger quote:
Speculation is like judging a beauty contest by guessing what contestant other judges will pick.
No so straightforward, right?
As I contemplated purchasing this stock I could hear Warren and Charlie whisper
Upon thorough analysis, does this promise safety of principal and a satisfactory return? Anything else is speculation
Trying to stay grounded in this truth, I considered the key vitals to judge the health of this stock.
What are these vitals?
Companies are like people — No, really!
You and I have vitals which get checked during a visit to the doctor or worse in the case of an emergency. Companies also have vital health signals.
Let’s take a look at a few of these.
It might take you some time, but you soon realize that any company is like a real person. We both share vitals.
But, there’s more.
If you had a single friend asking your perspective on the financial standing of a marriage prospect, a few questions may cross your mind:
Is the person employed? What’s their current cash position? Are they doing a good job paying their bills with a little something left over to save? #cash #profit
If they had to pay off all their debt today could they be ok or would they be way under water? #assets
Is this person growing personally and/or professionally? #growth
What kind of friends does this person hang around? Friends are like elevators, they are there to either take you up or down. Is this person surrounded by people likely to take them up? #people
You can apply a similar assessment to any security investment prospect.
Evaluating a Company
As a smart investor, you are scouting for undervalued stocks.
There are different ways to approach this. My favorite approach has been through value investing.
But, there’s an equally rewarding approach I have adopted without knowing it: Growth Investing.
How about a few quick contrasts?
On Reaping Returns:
Patiently waits for the market to bid up undervalued stocks
Seeks dramatic increases in a company's share price
On Financial Analysis:
Lingers more on the balance sheet. It needs to ensure that a company has enough asset (margin of safety) to survive and bounce back from bad times.
Focuses on the income statement and potential for growth. It is more willing to take greater risks. With the expectation that the strong performers will balance out underperformers.
Both approaches focus on individual company potential, not market trends or cycles.
How do these approaches compare upon closer analysis?
Let’s delve a little deeper.
Warren & Charlie’s Cradle — Value Investing
For the uninitiated, it’s worth fleshing out what this approach to investing really is.
- Assessing the value of a company (stock)
- Determining it is undervalued (based on its financials)
- Allowing for a margin of safety (a buffer between the current market value of a stock and its assumed intrinsic value)
- And purchasing the stock with the intent to hold until it reaches its intrinsic value.
You are buying and holding a stock you think is worth $1 at 50 cents.
At the same time, you are looking at the stock buy as if you were purchasing the whole company.
Evaluating intrinsic value is at the heart of this alchemy. We can turn to the man himself to see how he defines this.
Intrinsic value is the discounted value of cash that can be taken out of a business during its remaining life — Warren Buffett
This calculation takes into account future cash flow and changes in interest rate with changes relative to the value of cash.
Done right, it measures a company’s ability to deliver profits to its owners in the future.
With this investing approach, a company’s earning power needs to jump out at you.
A Worthy Approach — Growth Investing
“Skate to where the puck is going, not where it has been” — Wayne Gretzky
Thomas Rowe Price is to growth investing what Benjamin Graham is to value investing.
He played a big role in defining and promoting the concept of Growth Stocks.
Does the name ring a bell?
Growth stocks not only display substantial and sustainable increases in earnings over time. They are also leaders of the pack in their respective industries. You are seeking growth that outpaces inflation.
So, with growth investing, you have to pay attention to some extra details other than what’s in the books. A few key elements include:
- Economic conditions
- Business practices
- Government policy
Armed and informed on these, such an investor then scouts publicly traded companies poised to take advantage of these factors in a specific domain.
This approach requires looking ahead and some foresight. Thinking about companies that can take advantage of new eras. You are trying to go where the puck is going.
Does it feel a little like speculation?
One key difference is that it is grounded in some truth on which to base these projections.
With growth investing, your attention is on what’s happening around the world and in the books.
Checking The Boxes-Step by Step
A very important view of this approach is that a growth investor thinks in terms of the portfolio, not just one company.
T. Rowe Price had some subjective criteria for a high growth industry. They include looking for a company in an industry with these traits:
- High-quality research and development
- Limited competition
- Few government regulations
- Well paid employees but low labor cost
- Strong possibility for a high return on invested capital
- Superior growth in earnings per share
A speculator is likely not concerned with this information.
With this lens, a growth investor is keeping an eye out for industries with bright futures.
Like a value investor, you favor companies who are dominant (position or name brand) in the said market.
Much like a value investor, as a growth investor, you love to see sales and earnings steadily rising.
According to Peter Lynch, the only growth worth paying attention to is earnings.
Bringing It Back Home
As I stared at my screen this time around, I knew I was ready to pull the trigger.
It was much clearer to me how I arrived at this point.
Warren Buffett and Charlie Munger might have come to a different conclusion than I did. And I felt comfortable with that
Because this time around I was evaluating this stock for growth and not value.
I wasn’t taking advantage of a sale or discount, I was buying a DeLorean knowing its rarity made it valuable.
Sure, my evolution into a hybrid investor is still very much in progress. Yet, my confidence grows by the day learning from the likes of Berkshire’s top dogs, Thomas Rowe Price, and Peter Lynch to name a few.
We covered quite a bit of ground.
Starting off with some distinctions between a traditional investor and a speculator.
Then we explored how a company can be viewed as a person. And much like your heartbeat and blood pressure, a company also has vitals worth paying attention to.
You should now have a better idea of how different a value investor is different from a growth investor.
Wouldn’t it be interesting to examine some actual stocks through these lenses?
What could we learn about NFLX, MSFT, TCHEY, APPL, and DIS from this vantage point? Definitely makes for a great next post on this topic.
Thanks for reading and all the best on your learning and investing journey.
Note: This information is intended to be informational and based on my musings on investing. It is not to serve as professional advice for investing. That responsibility is yours and maybe your financial advisor’s.
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