Optimal value investing method?

[growthinvestor]

I have read and experimented a lot.

It seems to me the method can be systematized as follows:
1) Research and select quality companies, i.e. good track record with strong revenue and profits and growth.
2) Find a good entry price.
   a) "Buy wonderful companies at fair prices" -or-
   b) buy with a margin of safety, .i.e. below fair value 
3) Hold for many years while ignoring market noises. 
4) Accumulate more on price dips and corrections.
5) Cut or sell when fundamentals change permanently.
6) Build up cash holdings through dividends or other means or taking profit. 
7) Use cash for step 4) or to initiate new positions. 




Some questions:
1) step 2a) and step 2b) seem to contradict each other. Market is usually efficient and it is hard to buy wonderful companies with a margin of safety.  I have observed market to price in future earnings quickly thus driving up the stock price, even before the quarterly report is out.  (.e.g Netflix) . It is more feasible to buy with margin of safety during corrections and crashes. 

Since corrections happen on average once a year, is it recommended to buy only during corrections?

2) When to sell or do we really hold a stock forever so long the company is churning out stable earnings?
    My opinion is to sell when the company has reached terminal growth, i.e. the earnings no longer grow at double-digits.     However, this works only when the company is a growth company in the first place. 
But the problem is after selling, we'd never know what kind of future growth plan the company will have and may regret selling. 




Would love to hear your opinions.

[karlmarx]

There is a missing step between #1 and #2.

Entry prices are not 'found,' especially if you're referring to guesswork or 'technical analysis.'

To know what price make sense for the investment you're eyeing, you have to have an idea of how much the company is worth. To do that, you have to discount its future cashflows, and sometimes also use other valuation tools/metrics.

After you have arrived at how much you think the company is worth, then you can decide how much you are willing to pay for it.

All your questions will be answered if you know the worth/value of the investment you're eyeing.

[Wildreamz]

I think there are basically 3 pillars of investing: 1) A framework for accessing the attractiveness of an investment. 2) The right temperament. 3) An asset allocation strategy.

What works for me (for now):

1) Value Investing Strategy with a focus on long term growth prospect: Buying value producing assets below intrinsic value (less than DCF of future earnings), then buy and hold for the long term.

Great companies are often market leaders, with great management, on a secular growth trajectory (eg. Apple in 2010); can compound at a significant pace over extended periods of time (Amazon has compounded revenues at 30-40% for the last 20 years).

2) Must be ok if market price is cut by half tomorrow, as long as fundamental remains intact (eg. Apple in 2012, 2015).

3) Usually fully vested (>90% of investable capital), in less than 10 ideas at a time. Only sell when can replace current investment with more attractive investment, or when original investment thesis proven to be false (liquidity event). In case of a forced liquidity, may need to hold cash for substantial periods until sufficiently attractive opportunity appears (based on risk to reward ratio).

If you find a company that is growing very fast, at a very early stage of their growth cycle, with strong moat/market leadership/competitive advantage can just initiate full position. There is rarely a significant pull back, and in 1-3 years, usually the company just "grow into" their valuation (eg. Facebook in the last 5 years, from 100+P/E to 20+ P/E).


Personal style, requires less work on a day to day basis IMO (after awhile, you end up with a portfolio of strong companies that maintains stable over extended periods of time).

[Wildreamz]

Some questions:
1) step 2a) and step 2b) seem to contradict each other. Market is usually efficient and it is hard to buy wonderful companies with a margin of safety.  I have observed market to price in future earnings quickly thus driving up the stock price, even before the quarterly report is out.  (.e.g Netflix) . It is more feasible to buy with margin of safety during corrections and crashes. 

Since corrections happen on average once a year, is it recommended to buy only during corrections?

Sometimes fast growth itself is a margin of safety. eg. If a company grow earnings 25% for 3 years, they would have doubled earnings. Even if you paid 20-30 P/E 3 years ago when you made the purchase, you would have effectively paid only 10-15 of today's P/E.

When to buy what, IMO solely depends on what the market gives you. If you happen to have fresh cash during a correction, great. But if you don't, time in the market almost always better than timing the market IMO.

2) When to sell or do we really hold a stock forever so long the company is churning out stable earnings?
    My opinion is to sell when the company has reached terminal growth, i.e. the earnings no longer grow at double-digits.     However, this works only when the company is a growth company in the first place. 
But the problem is after selling, we'd never know what kind of future growth plan the company will have and may regret selling. 

IMO, usually when foreseeable long-term earnings growth/returns fall to single digits (ie. only in-line with average market returns), a better opportunity would have arrived that forced you to switch out your investment. Whether the company could sustain high double digit growth/returns depends on your personal, largely qualitative assessment (how big is the total addressable market? how eager and capable is the management at seizing new markets while maintaining margins?). If future plan is unclear, and you can never foresee how the company can sustain growth trajectory at a pace you like, then it is not the investor's fault for selling out early and "missing the boat". 

For the case of Netflix, I think the total addressable market is enormous, and they could probably sustain their current trajectory for quite some time. Whether or not it will translate to sufficient shareholder returns to justify today's valuation is another matter.

[growthinvestor]

There is a missing step between #1 and #2.

Entry prices are not 'found,' especially if you're referring to guesswork or 'technical analysis.'

To know what price make sense for the investment you're eyeing, you have to have an idea of how much the company is worth. To do that, you have to discount its future cashflows, and sometimes also use other valuation tools/metrics.

After you have arrived at how much you think the company is worth, then you can decide how much you are willing to pay for it.

All your questions will be answered if you know the worth/value of the investment you're eyeing.

However, many good companies have their prices at or above fair value when I decided to invest in them. 

Many other risk-taking traders and investors would have priced in the companies' future earnings and don' mind paying premiums above fair value.

In such cases, do I buy at fair value or wait til a correction?

What do you do?

[karlmarx]

Your conundrum concerning:
a) "Buy wonderful companies at fair prices" -or-
b) buy with a margin of safety, .i.e. below fair value

is a false dichotomy. Buying at low p/e and p/b doesn't mean you're buying below fair value. Likewise, buying at the market average p/e and p/b doesn't mean you're buying at fair prices.

Whether the price you pay for a business is 'fair' or 'cheap' or however you might want to describe it, depends on your valuation of the business. For example, a business with p/e of 20, p/b of 2 has a market value of $1. Looking at p/b and p/e metrics, it might look expensive. But my DCF valuation shows it is worth $2. Cheap!

How can my DCF valuation show that it is worth $2? Only because I have projected that the business can continue to grow at super high rates over a long period of time.

You will have to project the future cash flow of the business you're looking at, and discount that to the present (i.e. discounted cash flow). And then compare that valuation to the current market price.

WB didn't really change his style of investing when he went from looking for cigar butts to moats. He still looked for what is cheap. But he moved from looking for what is cheap now, to identifying what is cheap in relation to the future.

[growthinvestor]

Thanks. I didn't mention p/e and p/b at all.

I just merely said .. it's may be hard to find prices below fair values (which could be derived using DCF or other metrics), especially so with a margin of safety.

I'm not sure whether it is because I am being too conservative or people are so optimistic about the future earnings that they project the DCF fair value to be high, much higher than current market price that they deem current price undervalued .
Also Quite often, FOMO and greed erode the safety margin or pushes the prices up rapidly. Many market participants do not buy based on safety margin and fair value, they just buy based on general "feel" or whatever reasons they have.

How often do you find that companies you want to invest have the required safety margin when you decide to invest in them?

It seems that one has to wait til a company is hit temporarily by some problem or a correction/crash in order to have this required safety margin.

[Wildreamz]

Thanks. I didn't  mention   p/e and p/b at all.

I just merely said .. it's may be hard to find prices below fair values (which could be derived using DCF or other metrics), especially so with a margin of safety.

I'm not sure whether it is because I am being too conservative or people are so optimistic about the future earnings that they project the DCF fair value to be high, much higher than current market price that they deem current price undervalued .
Also Quite often, FOMO and greed erode the safety margin  or pushes the prices up rapidly. Many market participants do not buy based on safety margin and fair value, they just buy based on general "feel" or whatever reasons they have.

How often do you find that companies you want to invest have the required safety margin when you decide to invest in them?

It seems that one has to wait til a company is hit temporarily by some problem or a correction/crash in order to have this required safety margin.

Curious to which companies and metrics you are looking at. Mind sharing? 

It's hard to value high growth companies, as it requires accurate projections of company earnings far out into the future.

Facebook grew net income from ~$1b in 2013 to ~$18b in 2018. Say you think FB should be traded at conservative 22x TTM earnings ($400b market cap) in 2018 (it's actually trading at 530b market cap right now), what should it be worth in 2013? Discounted back by 10%, it should be worth up to $250b market cap in 2013. FB was trading at $50-150b back in 2013, at a average PE of >100, but on hindsight, it was still undervalued. The faster the growth rate, the further out the growth is, the harder it is to value the company, but there is also more money to be made if the investor guessed correctly and stuck with the company long-term.

Many growth companies are going to fail to live up to expectations. Not all companies can sustain torrid growth rate for too long. So collectively, growth companies as a whole are often overvalued. But the market is still rational as investors are paying up for the opportunity to own the multi-baggers.

[growthinvestor]

Thanks. I didn't  mention   p/e and p/b at all.

I just merely said .. it's may be hard to find prices below fair values (which could be derived using DCF or other metrics), especially so with a margin of safety.

I'm not sure whether it is because I am being too conservative or people are so optimistic about the future earnings that they project the DCF fair value to be high, much higher than current market price that they deem current price undervalued .
Also Quite often, FOMO and greed erode the safety margin  or pushes the prices up rapidly. Many market participants do not buy based on safety margin and fair value, they just buy based on general "feel" or whatever reasons they have.

How often do you find that companies you want to invest have the required safety margin when you decide to invest in them?

It seems that one has to wait til a company is hit temporarily by some problem or a correction/crash in order to have this required safety margin.

Curious to which companies and metrics you are looking at. Mind sharing? 

It's hard to value high growth companies, as it requires accurate projections of company earnings far out into the future.

Facebook grew net income from ~$1b in 2013 to ~$18b in 2018. Say you think FB should be traded at conservative 22x TTM earnings ($400b market cap) in 2018 (it's actually trading at 530b market cap right now), what should it be worth in 2013? Discounted back by 10%, it should be worth up to $250b market cap in 2013. FB was trading at $50-150b back in 2013, at a average PE of >100, but on hindsight, it was still undervalued. The faster the growth rate, the further out the growth is, the harder it is to value the company, but there is also more money to be made if the investor guessed correctly and stuck with the company long-term.

Many growth companies are going to fail to live up to expectations. Not all companies can sustain torrid growth rate for too long. So collectively, growth companies as a whole are often overvalued. But the market is still rational as investors are paying up for the opportunity to own the multi-baggers.

I'm still quite new to investing.  
looking at local growth companies like micro-mechanics, Samurai, HrNet, Straco, ISEC, etc.

they have well above-average financials and margins compared to the rest  of the stocks.

MM and Samurai are def overvalued even if we use DCF valuation without terminal growth, yet market  still continue to chomp up the shares "pricing in future growth" like how crazy people keep buying Netflix & Amzn. 

I don't chase prices so I may miss the opportunity. There are always crazy forward-looking risk-takers around so conservative people will never have a chance to load up. 

FB gradually rolled out mobile ads, video ads, etc. after IPO on its existing large user base hence the sharp rise in profits. It's probably peaking and growth is likely to slow down a lot. 

If a market crash happens in 2019/20 as predicted by the yield curve, it may be a good opportunity to load up on these companies.

[Wildreamz]

I'm still quite new to investing.  
looking at local growth companies like micro-mechanics, Samurai, HrNet, Straco, ISEC, etc.

they have well above-average financials and margins compared to the rest  of the stocks.

MM and Samurai are def overvalued even if we use DCF valuation without terminal growth, yet market  still continue to chomp up the shares "pricing in future growth" like how crazy people keep buying Netflix & Amzn. 

I don't chase prices so I may miss the opportunity. There are always crazy forward-looking risk-takers around so conservative people will never have a chance to load up. 

FB gradually rolled out mobile ads, video ads, etc. after IPO on its existing large user base hence the sharp rise in profits. It's probably peaking and growth is likely to slow down a lot. 

If a market crash happens in 2019/20 as predicted by the yield curve, it may be a good opportunity to load up on these companies.

Netflix and Amazon are outliers, in that their business model and strategy require that they make little to no GAAP income. 

Amazon is trying to "plough-back" all "excess" profits into their business as consumer discounts (either through direct discounts or subsidized shipping cost) and "technology and content" spending. The latter is actually in the vicinity of ~$25 billion (this number was $5 billion in 2014). In similar vein, Netflix is sacrificing immediate profits by charging a very low subscription cost ($11/month; a number that many survey showed consumers are willing to pay much higher) and spending all excess profits on content creation and acquisition.

Investors in Amazon and Netflix are projecting what they would be worth in 5, 10, 20 years and discount back their price to the present.

Regarding Facebook, it's quite interesting actually, it is not purely a property monetization play. Facebook IPOed in 2012 with 1 billion users. Today it actually has 2.1 billion Monthly active Users (https://www.statista.com/statistics/2648...worldwide/). And that is not counting the growth of their other property such as Whatsapp, Instagram and Messenger. Also, like you pointed out, they have constantly found new way to monetize their existing properties, which weren't producing any profits in their early years. Even today, I think Whatsapp is not monetized at all and has lot's of room to grow. Also they are constantly building up new properties (Occulus, Whatsapp Payments, Facebook for Enterprise, Facebook Watch, Facebook Marketplace etc.), that may be quite interesting 5 years from now.

Regarding the companies you listed, I am not personally familiar, so several questions:
* Where do you foresee their earnings would be in 5 years? 
* What multiple do you think they should be trading for then?
* How big is their potential market?
* How likely would they be able to execute?

I think if you don't like the current valuation of these companies, I am sure you can find something somewhere.

Good luck!

(vested in Facebook)