Ten Foolproof Factors For Successful Value Investing
1. Process:
Commit to an investment philosophy that emphasizes capital preservation, patience, discipline and a rational decision-making process. The best value investors follow a defined process of analysis of value rather than focusing on outcomes. Since business valuation is a blend of both art and science, your analysis is only a best fit approximation not an accurate calculation of a businesss true intrinsic value.
2. Preservation:
Invest for capital preservation first and capital appreciation second. Preservation of capital is the name of the game. As Phil Town says Follow Rule #1. Never lose money. Value investing creates safety of principal and a satisfactory return.
3. Discipline:
Learn to be rational, not emotional, with your investment decisions. Dont allow yourself to get caught up in the media hype. Be able to assess the main drivers of a business and have the discipline to ignore the remaining noise. Only let the media inform you, not instruct your investment decision. Let journalists be journalists, not stock picks. Discipline investors dont chase after the current investment fad of the day or what may be popular on Wall Street. Disciplined investors dont abandon an investment at the first sign of trouble.
4. Profitability:
Focus on investing in businesses that have demonstrated over time a consistent ability to increase book value and return on capital. Ideally, the growth rate of book value per share (BVPS) and return on investment capital (ROIC) should be greater than 10% per year over 7-year, 5-year, 3-year and 1-year periods of time. Consistency is the key.
5. Debt:
Assess the level of long-term debt. A healthy company should be able to pay off any long-term debt within 3 years from current net income or free cash flow projections. The companys balance sheet will tell you what the company has in assets versus its liabilities or debt obligations.
6. Margin of Safety:
The intent of every value investor is to find undervalued stocks that do have future growth potential. Sometimes Mr. Market can misprice a high-growth stock that can then be picked up with an acceptable margin of safety as a value investment. Have the discipline to say no. Insist on a margin of safety (MOS) price before buying your shares. Buying stocks in down markets when they are cheap limits the downside risk for patient value investors.
7. Homework:
Use both quantitative measures (fundamental analysis) and qualitative measures (existence of a competitive advantage, quality of management team) to assess potential businesses. Pay attention to just key variables to evaluate a business; any other information is typically noise and doesnt add significant value. Do your weekly homework on your holdings. This includes verifying the fundamentals, looking at specific technical indicators, assessing any changes in competition, monitoring industry trends and checking out the management.
8. Timing:
When you invest is equally important as how you invest. Buy your great businesses at sensible prices. Your starting point matters. The price you pay determines the value you receive down the road. Value investors are often said to use a buy-and-hold approach to investing. What is key is that you buy at the right price, then hold.
9. Allocate:
Focus on owning just a few quality businesses. It is easier to keep track of 3 to 5 businesses than dozens in your portfolio. Invest significantly when the media and markets are most pessimistic. Pessimism lends to buying opportunities of value stocks. Allocate your capital wisely. Buy your shares in increments.
10. Patience:
Value investing requires a long time horizon. Patience is key to your success. Stock prices arent always rational. We dont know when Mr. Markets price for a stock will be in line with the true intrinsic value of the business. In the short run the market prices stocks based on investor sentiment. In the long run the market prices stocks according to the fair market value based on fundamentals.
These 10 key factors to successful value investing can be summarized into five essential steps, as follows:
1. commit to and follow a sound investment philosophy based on patience, discipline and risk aversion.
2. develop a good search strategy for potential businesses.
3. effectively value each business, knowing that it is an estimate at best.
4. have the discipline and patience to say no to opportunities until the right one comes along.
5. be willing to commit a significant amount of capital at the point of greatest pessimism in the stock or the market.
To your ongoing success as a value investor.
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