Value Investing-2

We start today with our discussion on “Value Investing” and try to understand the basic underlying concept. 
This concept was first developed and practiced by Benjamin Graham, the first Guru of value investing. He presented it to the financial world in 1949 through his book ” The intelligent investor”. The book was an instant hit and is still being published through numerous editions and reprints.  Value investing was further taken forward by Warren Buffet, Charlie Munger & Peter Lynch. 
Warren Buffet, now 88, is widely acknowledged as the biggest investor of all times and is CEO of Berkshire Hathway having the market capitalization of over 500 billion USD and consistently earning 21% for the shareholders for the last 50 odd years. In comparison, S&P-500 has returned an average of 10% during this period. (S&P 500 and DJIA are American stock indices like our own BSE & Nifty)
Peter Lynch, the manager of the Magellan Fund at Fidelity Investments between 1977 and 1990,  averaged a staggering 29% annual return consistently,  more than doubling the S&P 500 market index and making it the best performing mutual fund in the world. He has authored the book “One up on the wall street”. (This book is more interesting read than Ben Graham’s The intelligent investor)

Produced below is a calculation on returns using calculator.net to give you an idea in absolute terms of what you would get with the kind of return percent on different investments and also to make you realize the power of compounding.

Invested today Rs. 1 lac Compounded annually	5 years	15 years	25 years
Peter Lynch 29%	3.57	45.59	581.76
Warren Buffet 21%	2.59	17.45	117.39
Indian Mutual funds/stocks investment assuming a minimum of 15%	2.01	8.14	32.92
Real Estate max 12%	1.76	5.47	17.0
FDs 8% (Depending on RBI governed interest rate regime)	1.47	3.17	6.85
Gold 3.5% (for last 50 years) However it acts as an insurance against black swan events	1.19	1.68	2.36

You can see from the above table how the increasing rate of return and also increasing investment horizon (no. of years) contribute to immense wealth creation. The longer the horizon, better are chances of success if the basic process isstrictly adhered to. Admittedly, we may not get much benefitted by the magical power of compounding at our age but our children will, if we can initiate them at a young age.
What is value investing: Value investing is the investment in stocks  for long term and at fair value, based on a well-defined selection process 

Step-1: Value investing is a process wherein stocks are selected for investment on the basis of easily understandable business, financial parameters, long term growth prospects, Industry growth prospects, competition scenario, Management quality, niche business etc. A risk analysis is then carried out to evaluate the stocks on different parameters and final selection depends on applying the risk filter. In short, look for stocks which have value. 

Step-2: Once the business is selected for investment, check if it is available at a fair price. This is very important. For example, when we go for say, buying a TV, we look for quality brands, desired features and best price. A very good brand with best features but at an exorbitant price will not be value for money. The price has to be in the proportion of quality and features. Similarly, a good stock bought at a fair price is likely to give good returns and a better stock bought at a high price may fail to give required returns. There are established methods to value a stock price and we will look at them in due time. The investment decision is essentially a long term one, aspiring to own a small part of the selected business and get adequate returns. You are actually looking to own an asset and get returns through sweating of that asset.All the stock recommendation services available in the market carry out this exercise before recommending a stock. However, all of them may not be impartial. I am subscribed to one such service and I further filter their recommendations using my own criteria.

Step-3: Once the stock is bought, monitor the performance regularly to ensure that the assumptions made to arrive at the investment rationale hold true and events are unfolding as expected. Else make necessary course corrections.
So finally, in a nutshell, value investing is a process to analyze stocks for value, buy at a fair price and then hold long term to create wealth.
Despite sticking to this time tested process, there will be some hiccups, some unpleasant surprises and some disappointments. The key is to look at the forest and not at the individual trees. If the overall portfolio is performing well with over 60 to 70% stocks performing as expected, there is no reason to worry. No one has been able to predict markets with perfection and no one ever will.The stock market is a strange and unpredictable beast.

In the next issue, we will look more closely at step one. 
Do revert with comments and suggestions.

Happy Investing

bhushan oke

bhushanoke@hotmail.com