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The Concept of ‘Value Investing’

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Value investing has long been a methodology used across a variety of sectors in addition to property; its usage has becoming particularly pertinent over the years as a solid strategy that can be used regardless of how markets are behaving.  We spoke briefly to David Kuo, from the well established investment and finance website The Motley Fool, on a range of topics relating to this wide and fascinating subject:

1) Can you explain who the ‘Motley Fool’ are, and a bit about your history? Sixteen years ago, two brothers, Tom & David Gardner, who believed that private investors could be as good as professional at managing investments if they were given access to the right information, set up The Motley Fool in America. We call ourselves Fools (with a capital “F”) because the Fool or Jester was the only person in Shakespearean times who could tell the truth without risking his life. Our logo is the jester and we have offices in both the US and the UK. We communicate with our visitors through our daily investment articles, weekly podcasts and discussion boards.

2) What exactly is ‘value investing’? Value investing, as far as shares are concerned, means buying shares that are unreasonably cheap. So if you can buy a share that is cheaper than other similar shares, and there is no obvious reason for that cheapness other than perhaps market sentiment, then you may have a share that represents value. It may therefore offer above-average growth prospects. Put another way, if you can buy pound coin for 80p, then that represents value.

3) Can you discuss the history of the concept please? Value investing can be traced back to Benjamin Graham who is regarded as the father of value investing. Graham would trawl through mountains of company accounts comparing the intrinsic value of a company with the market price of the business. The two are not necessarily the same, and when the price is significantly lower than the intrinsic value, Graham would buy the share and wait patiently for the market to recognise the true value. These were known as “cigar butt” companies because they had a few puffs left in them.

4) One of the main principles of value investing – is that you continue regardless of what the market is doing (ie. bullish or bearish) – can you explain this a little further? Markets can be driven as much by sentiment as it can be by value. When investor sentiment is poor, there is a good chance that shares may fall to reflect this even though nothing fundamentally may have changed in the business. This is an example of how value and price are out of sync with each other. This would represent a good opportunity for value investors to investigate further, perhaps buy the share if they are cheap enough and wait for the value to be outed.

5) Is it complicated to apply? With value investing, the cheapness is measured by popular ratios, such as price earnings, price to book, yield, and other factors about the company like the level of its debt. Shares are screened to look for shares whose P/E is two-thirds of the market; the yield is 50% above the market; the shares are below the net book value of the assets and with little or no debt.

6) Can you name some prominent investors / investment companies who are using the concept today – and how? Perhaps the most well known, modern-day exponent of value investing is Warren Buffett. The legendary investor is renowned for his many quotes and perhaps the one that best encapsulates value investing is: Be fearful when the market is greedy and be greedy when the market is fearful.

7) Why has the concept be viewed as some as ‘contrarian’? That is because it flies in the face of herd mentality. We have to remember that financial markets are actually different to other markets that we may be more familiar with. For example, if the price of eggs goes up, people eventually start buying fewer eggs. But in financial markets, at least over the short to medium term, rising prices causes people to buy more, because if people think, I want to ride this tide. Disciplined value investors on the other hand will ignore sentiment and sell once the value in the share has been outed.

8)How important is the concept of ‘value investing’ to your own strategy and those at the ‘Motley Fool’? Value investing is one of many disciplines that also include high-yield investing, growth investing and momentum investing. There is no right or wrong discipline only one that is right for you.

9) Are there any risks / downsides? There is no investing Holy Grail. There are risks associated with any style of investing, for instance, high-yield investing is often perceived as one of the safest. But recent events with the banks and BP has shown that even reliable dividend payers can trim, axe and slash their dividend payouts.

10) What are the the factors to be vigilant of if going for a value based investment strategy? It is vital to build into the value calculations a health margin of safety to ensure that you buy the shares at a sufficiently low price. There is a possibility that the shares could fall further, which is why it is important to cut your losses if that should happen. Warren Buffett once said there are two important rules of investing: The first is do not lose money. The second is never forget rule number one.

11) Today, with a more realistic property market backdrop (where prices are perhaps at a more realistic level than before the onset of the recession), there are more property investors looking apply value-based concepts – how do you think it this can be done specifically for property and land? Property and shares are the only two asset classes that have beaten inflation over the long term. Consequently, there are similarities between the two. If you can buy an asset at a generous discount to its book value, manage to generate a market yield and do so without taking on excessive debt, then you may have found yourself a value property that you can hold until the value is outed. Personally, I would prefer to look at Real Estate Investment Trusts where the market is more liquid.

12) If investors wanted to read more into the concepts – what references would you recommend? The definitive book on value investing is Benjamin Graham and David Dodd’s Security Analysis.  Our resident value investing expert, Stephen Bland, writes a weekly article in which he identifies his value picks, and explains why and how he has chosen them.

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