Price
versus Value of the Shares
Learn how to
guess the value of share in a couple of years rather
than the current price.
Someone has wisely said: “True
investing is about asset performance, and true speculation
is about price performance.” Most investing
operations fall somewhere in between. But unlike speculative
operations, they involve thorough analysis, and only
then do they promise safety of principal and an adequate
return.
Investing has to be value driven, which means you
buy an item worth $10 for $4. The methods of driving
value of an investment depends on one’s valuation
technique, and understanding of the business. It is
important here to be able to distinguish between value
and price. Value is a combination of physical and
emotional needs, whereas price is only what one-pay
sin monetary terms. While price is well defined, value
cannot be expressed precisely.
The stock market is the only place where a company
worth $1 million can be sold at $10 million, and a
company worth $10 million can be bought for $1 million.
You must have an eye for the value price gap. There
are masters of this discipline too. Warren Buffet
created the world’s second-largest fortune by
investing in stocks. The key to his success has been
that he applies value-investing concepts margin of
safety in a disciplined manner.
Principles of value investing!
Value can be found in stockmarket investment by:
• Buying the balance sheet cheap,
• Buying the profit and loss (P&L) account
cheap.
Assets can be bought cheap at the time of adversity.
Most companies stocks were available for less in the
period after 9/11. But today the scenario is different.
It is the timing of investment that is also important.
In commodities, when the business tailwind becomes
strong, the profitable gap between the best and the
worst narrows dramatically, and pessimism gives way
to optimism. On the stock market, maximum money is
made when the company goes from very bad to bad.
To gauge whether one is buying the P&L statement
cheap, price-to earnings (P/E)-based valuation is
often used. Though it is easy to understand, most
mistakes are made while using this tool. The trick
in valuing earnings or sales is in deciding what multiples
should be given. If the business is not very capital
intensive and has a track record of sustained high
profitability because of high entry barriers, P/E
could be 10x. For genuine growth companies, it could
be much higher. Growth and quality of growth are important
before assigning a P/E multiple to companies’
earnings.
Retail investors should focus on companies with relatively
low P/E and P/S (price to sales ratio). Various studies
have proved that low P/E multiple companies, in general,
significantly outperform high P/E multiple companies
If you invest for more then a year, you have a good
chance of positive returns. Unfortunately, holding
periods for retail investors are coming down to below
a year. To sum it up, value investing calls for purchase
of stocks with adequate margins of safety and sitting
for years till it works out. This is the simple mantra.
|
