BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “THE RELATIONSHIP BETWEEN PRICE AND VALUE”

As we have discussed regarding value in the previous article of a Bibliophile. Now, I am going to talk about the 4th Chapter of The Most Important Thing – The relationship between price and value.

01 P&V

There is not an availability of any asset class which having a birthright for providing a higher return. If we bought a particular asset class at an appropriate price, then that provides us a higher return to safety.

02 P&V

An example of one the biggest wealth creator company of the Indian stock market—

INFY Chart

If someone has bought this company during the March-2000, At the high price of around Rs.431 then after the 16 years of the period, he gets returned at 7% CAGR. And if enter to the similar company at the low price of around Rs.275 during the March-2000 then after the 16 years of the period, he gets a returned of 10% CAGR (*Considering all time high price for calculating returns). Though revenue grew at 30% CAGR, Operating profit grown at 27% CAGR and Net profit also grown at 27% CAGR during the same period with supported by the good management team.

If we buy such a good thing at a too high price, then we have to wait for the very long time for getting fair returns rather getting superior returns. But if we have bought junk asset class or good asset class at an appropriate value, then we can able to create a superior return.

We should focus on correctly buying an asset at a cheaper price so that we need not keep focusing on the selling decisions. Because our buying decision provides us a huge safety. Whenever we buy any stock at a cheaper price and all our calculations of intrinsic value are correct, then over a period of time, the stock price should reach its intrinsic value.

So, that One of a good idea of making an investment is to buy whenever the pessimistic situations around us which provide us a good return with proper safety. But such scenario not always comes. This means we construct our portfolio at the time of crisis, but every time, we cannot stay only dependent on the crisis for making our buying decisions.

03 P&V

Thus, most important are to understand the relationship of price & value. By knowing the relationship between price and value, we can able to take an advantage of mispriced valued stock and consistently create a wealth for the longer period of time. We also need to understand the Psychology of investors along with the understanding the price – value relationship because the psychology of investors can drive stock prices in the short run. But at a longer period, the price should reach its intrinsic value. So, that it is an essential for us to buy an asset at a discount from its intrinsic value.

IT Bubble

Infra & Logistics

04 P&V

Investors Psychology is also one of the important factors along with the Fundamental value of the security which can drive stock prices to an extreme side and that provide us an opportunity for our entry/exit. We should avoid falling into the trap with short term price fluctuation due to the psychology of investors but should take an advantage from it.

05 P&V

06 P&V

RKD BUY

People never focus on the price at clever people make an investment. But they start herding towards the news of such deals. So, that more and more people start buying the same stock and due to the flow of buying, the stock starts rising and again more investor start buying into it and stock start rising again. Thus, psychology drives a price much more rather than its fundamental in the shorter period of time. Everyone starts creating stories after the clever people make an investment, those stories drive the price of the asset class at extreme direction.

As per the Howard Marks, there are few ways by which we can earn a profit on the investment:

  • Benefiting from rising in the asset’s intrinsic value.

In this method, an investor has to predict accurately to the improvement in the intrinsic value of the assets in the future. But this task is not as easy as it seems. We even don’t know our future and we are going to predict the future of the intrinsic value which is very uncertain in nature.

  • Applying leverage

Leverage means investing using borrowed money. Leverage always works as a double edged sword. It can either make you or will break you. It magnifies both gains as well as losses. So, leverage might provide us a higher return, but it can also create a threat to our own capital. Selling for more than your asset’s worth

  • Selling for more than your asset’s worth

Here, we need to hope for the buyer who is ready to buy an asset at a higher price. If we are holding an asset which is overpriced or fairly priced than we need a greater fool to buy an asset from us at a higher price.

  • Buying something for less than its value

In this option, we are buying an asset at the discount, from its intrinsic value. It’s just required for the proper functioning of the market and that brings an asset to its intrinsic value. This can be one of the most useful ways to make a consistent return with a safety of our capital.

Sultan Mirza

Click for Video — Sultan Mirza

As we have seen in the video that Ajay Devgan has bought Guava at a very high price compared to the real value of the Guava. We have many a time experienced such kind of the irrationality among the investors who focus on story prevailing at market space rather than focus on the real value of the particular stock. We will not always able to meet Sultan Mirza (Ajay Devgan) / Irrational investor who buy an asset from us at a very irrational price. So, that we always need to focus on the buying an asset at a discount from the real value for getting a consistent return to safety.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

SIMPLE IS BETTER – ISSUE -6 – HEALTH IS WEALTH

In the last five issues, I have discussed regarding compounding and its power and how we can able to take benefits of compounding for a longer period of time. But for taking a benefit of compounding, we need a time – a long time; with a good health. Otherwise, we cannot able to enjoy our wealth or might not be there to enjoy our wealth. So, that, in issue 6, I am going to discuss on our real wealth which is our health and how it is as similar as we make an equity investment. Also, additionally to improve our health and wealth which can help us in a longer period of time.

257-Health-and-Wealth-Quotes

By getting the benefits of compounding our money, we can be able to become a wealthy person, but if we do not have a good health then that compounded wealth is of no use. So, that we also need to compound our strong health for enjoying our compounded wealth in a longer period of time.

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -6 – HEALTH IS WEALTH

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “VALUE”

In the 3rd chapter of the book “The Most Important Thing”, Mr. Howard Marks has discussed regarding different ways to identify the value of any business.

Hope

We always make an investment at a lower price with the intention to sell it at a higher price. Means that we buy something at less price than we can able to sell.

But what is high, price and what is a low price? How to identify it? That is the main confusion for all of us.

For taking it at a simplify manner, we can say that we buy at below the intrinsic value of any assets for selling that asset at a higher price.

“Intrinsic value is the value (i.e. what the company is really worth). Different investors use different techniques to calculate intrinsic value.” – InvestorWords

Now the question is how to identify an intrinsic value? As we all know that there is a major 2 discipline to identify an intrinsic value of the company’s securities.

1) Fundamental Analysis and,

2) Technical Analysis

Technical Analysis basically studies past behavior of price and from that past behavior, person predicts future price behavior.

I am not going to discuss this study in details because it’s not suitable to me and I am not able to make decisions based on past price behavior.

Move forward to the Fundamental Analysis, which is suitable for me and am comfortable with it. But again, a Fundamental Analysis also having two approaches to making a decision for an intrinsic value.

1) Value Investing and

2) Growth Investing

We need to Valuing a company by depending on a finance resource, management, business, plants & machines, factories, intellectual properties, human resources, brand name, etc.; which all having a potential to grow earnings of the particular company. And that is what we study into the fundamental analysis.

Then what is the main difference between value investing and growth investing?

Now, let me talk about the concept of valuing the company through value investing approach.

Value Investing generally focuses on tangible assets, current earnings, cash flow for valuing a company. This concept gives less weight to the intangible assets such as human resources with talents, future growth prospects, etc.

Value Investing focus on buying a company at a cheaper value based on its financial metrics such as current earnings, cash flow, dividends, tangible assets and enterprise value. Value Investors qualify the current value of the company and buy it when the current value is much higher than trading price.

Value Investing is also known as “net-net investing” approach, where investors try to identify the company which is available at below its current asset value.

Whereas growth investing focuses on to identifying companies which having a very bright future growth prospects. Here, no focus on the current value of the company and also given more weight to the intangible assets.

Difference GI VI

The Happy

Still having a confusion for selecting an approach for determining a value of the company.

If we have bought a security of a company which is available at cheaper than the current price, but at the operational level, the company is not able to do well enough, then that value cannot able to remain sustainable for the longer period of time. The value will get decompound rather than be getting compounded in the future. And that increases our probability of incurring the loss.

I read one wonderful article about the value trap company.

MTNL

The company looks very cheap on the basis of the financial metrics, but if someone who do not have paid attention to the business of the company then—

MTNL Chart

An investor has lost his capital also. So, that in value investing also, we cannot escape from the future. (For detail article, Kindly visit – http://neerajmarathe.blogspot.in/2010/04/mtnl-value-trap.html)

For the growth investing

GI

But is it such easier to perform?

Let me take an example of one the biggest wealth creator company of the Indian stock market—

INFY Chart

If someone has bought this company during the March-2000, At the high price of around Rs.431 then after the 16 years of the period, he gets returned at 7% CAGR. And if enter to the similar company at the low price of around Rs.275 during the March-2000 then after the 16 years of the period, he gets a returned of 10% CAGR (*Considering all time high price for calculating returns). Though revenue grown at 30% CAGR, Operating profit grown at 27% CAGR and Net profit also grown at 27% CAGR during the same period with supported by good management team. During March-2000, the company was traded at 64x P/E at low price of Rs.275 and this multiple are common now-a-days.

There is a very thin line difference between Growth investing and value investing.

Value investing is more consistent in nature, but it’s not easy to find it out. It is not an easy task to valuing a company through value investing approach. I also learn this valuable learning after made the such mistake. If we don’t able to make our estimate appropriately than we might overpay or underpay to that particular security. If we overpay for some security, then we have to take support of good luck for getting some greater fool who buys securities from us at a higher price.

Also, the most important thing is not to just valuing security appropriately, but also, we need to hold it. Stock will not start moving up after we make our purchase. Stock does not know that we are holding it.

After our purchasing, many a time price will start to fall further. But we should hold to it firmly. If something good at price X then it will be more good at price X-1.

Fig3-1

This law of demand is not really put by investors into practice in the stock market. We tend to buy more stock when the price starts moving up. But if we have done all our work properly, then decline in the price of security should not make us uncomfortable and we should also need to add more at a lower level.

Last

Read for more detail: The Most Important Thing Illuminated by Howard Marks

Disclaimer

Above article is just my perception, and perception can be wrong. For me, my perception can be right but for others, it might be wrong.