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16-11-2020, 09:57 AM
1) Value investing is implemented differently depending on whether you are a quant or a discretionary investor, which causes some confusion.
To simplify, quants use a valuation multiple to proxy for value (e.g. PB, PE, Div yield), and go long/short the cheapest/most expensive bucket. This style has breadth (you don't have to study each business individually), and relies on law of large numbers to kick in (which is why they have large number of holdings), and the intent is to extract the well-known "value premium". Of course quants know that value and quality/growth are joined at the hip - high ROIC businesses that can grow rapidly with minimal capex definitely deserves a higher valuation. Quants do not argue against that, instead they are betting that humans tend to wrongly extrapolate past trends (believing that high margins/growth will continue perpetually), which causes low PB/PE stocks to be undervalued, and vice versa. Downside of this style: you are essentially doing relative valuation, buying stocks that are "relatively" cheaper, and this could be dangerous if overall markets are expensive - you can win in relative terms, but still lose in absolute terms. Quant value investors have generally suffered over the past 10 years.
Discretionary investors (at least the real ones) is all about understanding the difference between intrinsic value and price. Intrinsic value is simple but difficult, it's just sum of future discounted free cash flows, an easy concept that's difficult to implement. Within this camp, you have the very conservative ones (focus on liquidation value), the normal ones (focus on stable, cash generative ones), and the dreamers (focus on companies that are EXPECTED to generate a lot of FCF in the future, but has yet to generate much now). The dreamers have done well in recent years, but I always felt that it's more luck than skill when you are doing value investing that way.
2) Damodaran is a great academic - I've read all of his books for his frameworks/mental models when it comes to valuation. But as I alluded to earlier, intrinsic value is easy conceptually, but hard to implement practically. I might be arrogant to say this, but Damodaran IMO is pretty bad at actually valuing a business correctly (by correct, I mean you beat the market). When I had lots of spare time a few years back, I went through all his valuations on his blog, and calculated his stock picking performance, and it was pretty bad. So my view has always been: read his materials to obtain the tool, but figure out how to use the tool yourself.
3) Finally, as I said, value investing takes on different forms, and each form resonates with a particular personality/skill set. But fundamentally, the essence of value investing (regardless of which form) is all about
- Margin of safety: you get margin of safety by valuing the businesses honestly and rigorously, understanding what are the drivers that actually affect intrinsic value (free cash flows, discount rates, and growth of FCF, and everything that affects the above 3). Valuing Ho Bee is easier than valuing Tesla (which has most of its intrinsic value, if any, tied up in future cashflow streams). So it's hard for me to believe that someone can invest in Tesla with a reasonable MOS, when there's so much uncertainty over its future CFs.
- Controlling your emotions: the usual stuff - be patient, be disciplined, be arrogant (because you are essentially saying that you have an edge against the rest of the world when you decide on becoming an active investor), be humble (because you will be wrong very often, and learning from mistakes are more important than successes), be extremely rational, be independent-minded, be honest etc. Good investors are masters of their own emotions.
To simplify, quants use a valuation multiple to proxy for value (e.g. PB, PE, Div yield), and go long/short the cheapest/most expensive bucket. This style has breadth (you don't have to study each business individually), and relies on law of large numbers to kick in (which is why they have large number of holdings), and the intent is to extract the well-known "value premium". Of course quants know that value and quality/growth are joined at the hip - high ROIC businesses that can grow rapidly with minimal capex definitely deserves a higher valuation. Quants do not argue against that, instead they are betting that humans tend to wrongly extrapolate past trends (believing that high margins/growth will continue perpetually), which causes low PB/PE stocks to be undervalued, and vice versa. Downside of this style: you are essentially doing relative valuation, buying stocks that are "relatively" cheaper, and this could be dangerous if overall markets are expensive - you can win in relative terms, but still lose in absolute terms. Quant value investors have generally suffered over the past 10 years.
Discretionary investors (at least the real ones) is all about understanding the difference between intrinsic value and price. Intrinsic value is simple but difficult, it's just sum of future discounted free cash flows, an easy concept that's difficult to implement. Within this camp, you have the very conservative ones (focus on liquidation value), the normal ones (focus on stable, cash generative ones), and the dreamers (focus on companies that are EXPECTED to generate a lot of FCF in the future, but has yet to generate much now). The dreamers have done well in recent years, but I always felt that it's more luck than skill when you are doing value investing that way.
2) Damodaran is a great academic - I've read all of his books for his frameworks/mental models when it comes to valuation. But as I alluded to earlier, intrinsic value is easy conceptually, but hard to implement practically. I might be arrogant to say this, but Damodaran IMO is pretty bad at actually valuing a business correctly (by correct, I mean you beat the market). When I had lots of spare time a few years back, I went through all his valuations on his blog, and calculated his stock picking performance, and it was pretty bad. So my view has always been: read his materials to obtain the tool, but figure out how to use the tool yourself.
3) Finally, as I said, value investing takes on different forms, and each form resonates with a particular personality/skill set. But fundamentally, the essence of value investing (regardless of which form) is all about
- Margin of safety: you get margin of safety by valuing the businesses honestly and rigorously, understanding what are the drivers that actually affect intrinsic value (free cash flows, discount rates, and growth of FCF, and everything that affects the above 3). Valuing Ho Bee is easier than valuing Tesla (which has most of its intrinsic value, if any, tied up in future cashflow streams). So it's hard for me to believe that someone can invest in Tesla with a reasonable MOS, when there's so much uncertainty over its future CFs.
- Controlling your emotions: the usual stuff - be patient, be disciplined, be arrogant (because you are essentially saying that you have an edge against the rest of the world when you decide on becoming an active investor), be humble (because you will be wrong very often, and learning from mistakes are more important than successes), be extremely rational, be independent-minded, be honest etc. Good investors are masters of their own emotions.