Pension plans and leases are off-balance sheet bombs waiting to explode. A company that assumes a high rate of return on its plan assets may mean the company uses aggressive accounting. Companies with stellar balance sheets are takeover bait. Growth is composed of two parts: earnings and dividends. Revenue growth drives earnings. If revenue is rising faster than costs, net margin will expand and net income growth will exceed revenue growth. Revenue growth can come from selling more products both domestically and internationally, raising prices, or lowering prices that creates higher demand and lowers costs.
As part of the revenue discussion, he says that stock buybacks are great ways for a company to boost shareholder value providing it is done at a cheap price. Using debt to finance a stock buyback is less attractive than using free cash flow to pay for it. Companies that pay a large dividend tend to have stocks that drop less. When the price drops, the dividend rate increases, attracting more shareholders looking for income.
That buying demand supports the stock. Ratios such as price to earnings, price to cash flow, price to sales, price to dividends, and price to book are good ways to screen for stocks, according to Katsenelson. In addition, the traditional PEG ratio is focused solely on earnings and ignores dividends. Concerning the three QVG elements, he assessed whether or not you can use one or two of the elements instead of all three.
Each of the Quality, Valuation, and Growth dimensions is an important source of value creation. Katsenelson discusses active trading using the value approach. He says, "Anybody who invests in stocks should expect to commit capital for five years or longer.
He explains what he means by active value investing when he writes, "In the range-bound market you should employ an active buy- and-sell strategy: buying stocks when they are undervalued and selling them when they are about to be fully valued as opposed to waiting until they become overvalued.
He further explains the method: "For every company you find worthy of owning high quality and growth marks , set the optimal price or valuation levels at which it transforms into a good stock. First, determine the fair value of the company using the combination of relative-and absolute-valuation tools discussed in the Valuation chapter. Support this site! Clicking any of the books below takes you to Amazon.
Legal notices: "As an Amazon Associate I earn from qualifying purchases. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. The second has occurred over the past 10 years, a time marked by slow economic growth and aggressive monetary stimulus. Although the value premium can certainly disappear for longer than one would like, there is evidence that it is mean-reverting.
In other words, value stocks eventually become so cheap relative to growth stocks that the performance of value rebounds, and often quite sharply. Their paper concluded that in early the forecast one-year return spread of value relative to growth was near an historic high. In the present environment, value is not treated with quite the disdain it faced in the late s, but nevertheless it has severely underperformed growth for some time, particularly in the small cap segment.
As has been the case during previous value bear markets, there are both risk-based and behavioral theories as to why value has performed so poorly. From a risk-based perspective, some theorists argue that the risk of value stocks relative to growth stocks has changed during this period. A common behavioral explanation is that investors have overpriced growth stocks in an irrational quest for sustainable earnings growth during a period of lackluster economic growth.
Whatever the reason, the underperformance of value has meant increasingly attractive valuations. The value spread is one measure of evaluating how cheap value has become. The same approach can be followed for small caps. The nearby graph shows that while the large cap value spread is currently elevated but not quite at historical highs , the small cap value spread is at the highest level since , with the exception of the peak of the tech bubble in early As value spreads have widened considerably, does that mean that value strategies will perform well on a relative basis going forward?
Quite possibly, if history is a guide. Since , there have been just three times when the value spread for large caps has exceeded its level, the latest year for which data is available. Investing in value stocks has generated a long track record of superior performance relative to a strategy of investing in growth stocks. However, the value premium is not a constant, as value has encountered lengthy periods of underperformance.
One measure of this attractiveness is the value spread, which is currently at historically high levels, especially for small cap stocks. If past is prologue, it is quite possible that value will perform very well relative to growth going forward. Asness, Clifford S. Friedman, Robert J. Krail, and John M. Chabot, B,, E. Ghysels, and R. DeBondt, Werner F. Fama, Eugene F. Harvey, Campbell R. DeBondt and Thaler were among the first to associate the outperformance of value stocks with investor behavior.
In widely cited papers, Fama and French and find a value premium, but hold that it is a risk factor, and not a behavioral phenomenon. According to Morningstar, the Russell Value Index declined Graham also wrote the highly regarded The Intelligent Investor. The annualized return to HML for the subsequent three years was The information, analysis, and opinions expressed herein are for general and educational purposes only.
Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Past performance is not indicative of future results. Information obtained from third party sources are believed to be reliable but not guaranteed.
All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.
Graham first laid out his principles of value investing in his textbook Security Analysis. Graham popularized value investing with his classic stock investing book, The Intelligent Investor. Both books are based on stock investing lessons Graham and others taught in a popular Columbia Business School course in New York City. The Intelligent Investor first outlined what is now widely viewed as value investing. Market and group investment. Market when he was selling valuable stocks at low prices.
Graham believed the ability to make money is the only criteria by which you should judge stocks. To identify such stocks, Graham invented what he called the group approach. In the group approach, you identify criteria for undervalued stocks and search for equities that meet that criteria.
Graham attracted attention for claiming that stocks picked with his group approach gained value at twice the Dow Jones rate. Graham was an active investor who worked on Wall Street for decades. Graham was openly critical of the stock market, most investors, and corporations. Today Graham is best known as the primary teacher of his most famous pupil, Warren Buffett. The key criteria of a Graham value investment are that a company needs to be cheap and make a lot of money.
Unlike Graham, Buffett is willing to pay higher prices for companies he considers good. Buffett will buy more expensive stocks that meet his criteria. Another difference between Warren and Graham is that Buffett will buy large amounts of what he considers good stocks. When he analyzes a stock, Buffett pays the most attention to its cash flow and assets.
Buffett will pay extra for companies with a healthy rate of growth like Apple. Berkshire Hathaway will sell companies with a slow rate of growth. Another Buffett belief is that investors need to keep large amounts of cash on hand. Investors need lots of cash so they can take advantage of opportunities fast, Buffett teaches.
Investors also need cash to cover emergency expenses and to borrow against them. Like Graham, Buffett is a contrarian famous for his skepticism of the market, the media, investors, and the investment industry. Buffett dismisses investment fads, popular wisdom, professional fund managers , and new technologies.
In recent years, Buffett has become increasingly critical of the wealthy and the American political system. Buffett is a celebrity who has achieved rock-star status among investors. Buffett does not take a lot of risks in his investing. He makes large investments in stable, simple businesses, including insurance, consumer goods, retail, finance, and media.
Too many people are focused on short-term trading to make money, which is much riskier. Many people, however, swear by Buffett and his investing wisdom. Most value investors base their investing decisions on three basic concepts. Each of these concepts is a big idea that underlies value-investment philosophy. Instead, Buffett values companies he invests in as if he was buying the entire business for cash.
Once these investors calculate intrinsic value, they compare it to the share price and market capitalization. If the intrinsic value is substantially higher than the market capitalization, you can consider the company a value investment. Buffett arrives at the intrinsic value by studying financial numbers and doing real-world research on its business model and competitors. A simple way to think of intrinsic value is the cash value of everything a company owns.
A slightly more complex estimate will include cash flows or projected cash flows. Most value investors use several methods of analysis to arrive at intrinsic value. There is no single best formula for intrinsic value. Instead, investors usually base intrinsic value on the calculation that best fits their belief of what makes a great company. In classic value-investing theory, the margin of safety is the level of risk an investor can live with. The margin of safety is an estimate of the risk a stock buyer takes.
This metric the single most significant valuation metric in our arsenal as it is the final output of detailed discounted cash flow analysis. Another name for the margin of safety is the break-even analysis. The break-even analysis is the share price at which you can begin making money from a stock.
Today the Margin of Safety is one of the key concepts of value investing. There are many risks that fundamental analysis cannot estimate, including politics, regulatory actions, technological developments, natural disasters, popular opinion, and market moves. The margin of safety you use is the level of risk you are comfortable with. If you are risk-averse, you will want a high margin of safety.
A risk-taker, however, could prefer a low margin of safety. Classic fundamental analysts examine the qualitative and quantitative factors surrounding a company. Both value and growth investors use fundamental analysis. To understand value investing, you need to have a good grasp of fundamental analysis, intrinsic value, and margin of safety. Not all value investors use these concepts.
Buffett will occasionally purchase stocks he likes, even if the market price exceeds the margin of value. Investors need to understand these concepts are theoretical guidelines and not concrete rules. There will be many stocks that make money but violate some value investing concepts. There is no universally best method of valuing a company in value investing.
Value investors, instead, use a variety of valuation methods. There is no perfect method for valuing a company. Most value investors have a favorite method, but their choices often reflect preferences or prejudices rather than results. Value investing is ultimately a matter of strategy. Thus, we can think of value-investment masters like Buffett and Graham as strategists. The Graham strategy is to seek stable low-priced companies that generate lots of cash.
Graham and Buffett ultimately diverged a little in their strategies. Buffett considers cash flow, growth, and the margin of safety important. Graham considered the margin of safety as the most important aspect of value investing. In the Buffett strategy, cash flow is a tool for growth.
A cash-rich company can afford to upgrade its technology, expand into new markets, develop new products, increase marketing, and borrow large amounts of money. Thus, a cash-rich company is more likely to grow. Buffett designed the strategy of buying growing companies to ensure growth and cash flow. Graham designed his strategy to create a wide margin of safety by spreading the investment over many stocks.
The Buffett strategy generates cash by concentrating investment in cash-rich companies. Dividend value is used by both Graham and Buffett because it ensures a steady flow of cash. The difference is that Buffett and Graham use the dividend value differently. Graham strategists view a high dividend yield as a means of increasing the margin of safety.
Buffett strategists see the dividend yield as cash they can use to fuel future growth. Franchise value is key to the Buffett strategy but ignored in the Graham strategy. Buffett will pay more for companies with strong franchises because he thinks strong franchises make more money. In the Graham worldview, the share price can tell you if a company is overpriced or underpriced. Graham strategists think of share price as a measure of the margin of safety.
In the Graham world, the higher the share price, the smaller the margin of safety. A popular view of Graham investors is that investors pay less for stocks they dislike and boring stocks. Modern value investors use the slang of sexy and unsexy stocks. These people seek good stocks that the market does not appreciate.
A Graham value investor could buy an oil company instead of a tech stock, for instance. The oil company is old-fashioned, boring, and offensive to some people, but it makes money. The tech company is attractive and flashy, but it could make no money. Buffett thinks that popular opinion and the media create market irrationality. Buffett watches the news and looks for bad news about good companies. Buffett will sometimes buy companies after a well-publicized scandal.
The public turned on Bank of America after news reports alleged some of its employees were writing fake loans to get commissions. Buffett bets that most news about companies will be inaccurate, limited, short-sighted, biased, and incomplete. Buffett tries to capitalize on that lack of information by having more information than the rest of the market.
Buffett reads financial reports; instead of newspapers and blogs because he thinks financial data gives him an edge over other investors. Buffet assumes that most investors do a poor job of valuing companies because they rely upon inaccurate media reports. The most popular value investing strategy is diversification, which they design to create a high margin of safety. Diversified investors assume most people make poor stock choices.
The diversified investor tries to counter the poor stock choices by buying various stocks that meet his criteria. A diversified investor who seeks dividend income will buy high-dividend yield stocks in several industries in an attempt to create safer cash flow.
A diversified investor who seeks franchise value will buy stocks in companies with high franchise values. Buffett buys a variety of growing cash-rich companies to create high cash flow. B will always generate some cash from its many businesses. Understanding the strategy is the key to learning value investing.
All good value investors are good strategists. The ultimate goal of a successful value investor is to design and implement a successful value investing strategy. The fact is, it is great to learn and understand the history of value investing, and grasping the concepts allows you to decide if you want to be a value investor or not. The truth is that today value investing and dividend investing are a lot easier due to the power of the internet and web-based service providers that do the hard work and calculations for you.
Excel spreadsheet calculations are a thing of the past as serious compute power enables you to scan for your exact value investing criteria in seconds across an entire stock market you find your potential new investments.
We have a number of practical guides written and tested to enable you to follow a few simple steps to begin to build your value portfolio. The biggest advantage of successful value investing is the capacity to make solid profits over time. Sometimes, value investments can lead to dramatic revenue growth. This is a Berkshire Hathaway shows value investors can make a lot of money if they have patience.
There are other advantages to value investing that make it worthwhile even if you do not make a lot of money. That advantage is simplicity. The complexity of many investment systems can frighten even intelligent people away from the markets. They base most value investing systems on a few simple principles, which makes it easy for ordinary people to grasp those strategies. Plus, Graham concepts like Mr. Market successfully teach investing philosophies to ordinary people.
The Mr. Through Mr. Market, Graham teaches that the market is irrational and impossible to comprehend. Yet Graham shows how anybody can take advantage of Mr. People who observe Mr. Market can find bargains and make money. Using a simple system means there is less that can go wrong. Buffett also uses simple stratagems anybody can understand. Buffett famously refuses to invest in any company or instrument he does not understand. Berkshire Hathaway did not start investing heavily in tech stocks until recently, for instance.
By using this rule, Buffett avoids unknown risks and steers clear of markets beyond his expertise. Re-reading the book cover to cover again, the first impression has lasted. Part I is an impressive tour- de-force into why we are in the age of a range- bound market, broadly estimated to last between the years Written in with the markets at around ATH it took considerable cojones to make his argument as forcefully as the author does as can be said today again.
The importance of the range-bound market concept is needed to set the stage for the practical application of bottoms-up value investing techniques. Katsenelson is clearly concerned the pure value investor might cringe seeing this focus on the broader market. A core commandment of the valuation minded investor is arguably the belief around the equity markets being a market of stocks rather than a lump-sum stock market.
Hence, this part is crucial to all active investors except the buy-and-forget-to-sell crowd that tend to grow in times of pro-longed bull markets. And range-bound markets occur more frequently than you might think; about half the time in the last years.
An important caveat is exactly that; the author separates what he terms cyclical markets within the longer pull-and- tug between secular markets, whose average tenure is 17 years. The question is if it will remain so, with the rules of central banking being re-written as we speak, ushering in a new cast of intervention-prone actors in the monetary play, funnily enough correlating with more boom-bust cycles than ever before.
But, equity market cycles have been brilliantly illuminated before. It is in Part II — the practical applications section — being introduced to the QVG framework, that my scribbles, notes and references occupy almost every page. It is truly shared knowledge and very transparent — a practical guide more than anything. First and foremost, QVG treats investing as stock picking one company at a time, rather than pushing stocks into themes or styles, like sheep into their designated hemming.
Fastenal was not a great investment because it ex-post fits into quality criteria; it was a great investment because of corporate execution, a thriving market and a juicy starting valuation. Add to that a suggested framework to incorporate into company research, and the only question remains: Do we have to wait until the year for Active Value Investing, 2nd edition?
Jun 18, Douglass Gaking rated it it was amazing Shelves: business-economics. I read a lot of books about finance and investing, and this is one of the best. It is that good. Katsenelson's model for active value investing is designed for range-bound markets but works very effectively in all markets. He focuses on evaluating stocks for quality, valuation, and growth QVG , then m I read a lot of books about finance and investing, and this is one of the best.
These work great no matter what is happening in the market. For example, right now there is a lot of uncertainty and volatility in the market, and inflation is on the rise. This has caused me to question my price targets and have trouble determining what the fair value of a stock is. The book does not do much to address this, but that is really the only criticism I have.
After experimenting with different types of value investing over the last 5 years, I started focusing last year on an active value investing strategy that uses a combination of valuation and technical analysis to trigger buys and sells. While reading this, I started plugging some of the book's formulas into spreadsheets and applying them to my strategy. I highly recommend this book to anyone who is interested in long-term stock investing, especially if they want to enhance returns with a more active approach than buy-and-hold.
In addition to having a great model, it is well written and has good advice about investing in general. Aug 25, Ted rated it really liked it Shelves: investing. A very good take on the basics of value investing. I particularly like the models and formulas that Katsenelson spells out.
I would LOVE an updated version of this book and it would probably earn an extra star. Written in , the book portends a range-bound market when, in fact, both opposites occurred: the "Great Financial Crisis" followed by a year bull market. I don't fault the author for not catching thos A very good take on the basics of value investing. I don't fault the author for not catching those, but this fact does strain the relevance of the premise of the book.
We find ourselves in with slowing global economic expansion and world-wide interest rates on the low end of the spectrum, so a range-bound market is well within the realm of possibility. Second edition, please! Jun 14, Carlos Villegas rated it it was amazing. De mis mejores maestros Katsenelson.
Dec 15, Sheep Invest rated it it was amazing. As a fairly new investor, this is the book that has influenced my investing style the most. Just like for any other valuation model the usefulness of i As a fairly new investor, this is the book that has influenced my investing style the most. Just like for any other valuation model the usefulness of it is dependant on the quality of the inputs, so you still have to do all the work in learning about the quality of the company and its future growth prospects, and so on.
For me this was a very useful tool to have during the recent corona crash. As everything fell, even companies whose businesses were not negatively impacted by the virus, I think having some hard numbers to look at helped me stay somewhat rational. If you're an experienced investor with a succesful strategy that has served you well over many years this book could perhaps come across as too basic, but for the new and intermediate investors I absolutely recommend it.
Dec 07, Brian Zheng rated it really liked it. This is a good "How to do it" book following up on the Secular Stock Market Cycles thesis, the idea brought up in that I reviewed before. The core of the book is the Quality, Valuation and Growth framework and the author presented a guidance formula to decide the PE ratio to buy or sell a stock taking consideration of quality, growth prospect of the business and margin of safety to valuation.
Sep 08, JK rated it liked it. Basic, common illustration with foundation in value investing explained. Easy for beginner to read. For intermediate investor, it might worth some time to recapture some basic foundation and valuation view point.
The concept is to find a company with quality, growth, and valuation, just like other value investing books. However, Katsenelson not only recommended buy undervalued stocks, but also sell it when the stock is overvalued. The idea behind this is that stock price always fluctuated within Basic, common illustration with foundation in value investing explained. The idea behind this is that stock price always fluctuated within a range, created opportunity to buy low and sell high for higher profit rather than buy-and-hold strategy.
The valuation method discuss in book is based on PE ratio which estimated based on profit growth and dividend yield. Easy concept to understand, and all the art for valuation is determine future growth rate and dividend yield. Mar 22, Colin rated it really liked it. While I agree with Ben on many of his points, I really do think this time period is analagous to the time period of , when the Dow stayed at points for almost 15 years.
Granted if the future resembled the past, we'd be able to predict it. I like this book because it seems there are so many books, articles and pundits who are overly optimistic, when in fact, there are many things to worry about. I admire Mr. Katsnelson's views, because he is holding contrarian opinions, which is very While I agree with Ben on many of his points, I really do think this time period is analagous to the time period of , when the Dow stayed at points for almost 15 years.
Katsnelson's views, because he is holding contrarian opinions, which is very hard to do in his industry. I think Mr. Katsenelson uses some great case studies and wished he had done more. Jul 02, Tyson Strauser rated it really liked it Shelves: strategy , investing. Since the end of the previous bull market in , we have been in a secular bear market. While Katsenelson thought this might express as a sideways, range-bound market, the result is the same.
We have seen market multiples collapse and Katsenelson's insightful views have been useful in navigating the bear market of Apr 30, Jennie Tao rated it it was ok. Read it over the weekend. I expected a lot from the book but found it too basic and common sense.
Others might find it useful though Jul 06, Joshua Norman rated it it was amazing Shelves: business-finance. One of the few required books for college classes that I enjoyed reading.
In this book, author and respected investment portfolio manager Vitaliy Katsenelson makes a convincing case for range-bound market conditions and offers readers. the answer can make a huge difference in your investment portfolio. In his recent book, Active Value Investing: Making. Money in Range-Bound Markets (Wiley. athlete's terrific performance – the steroids. Value investment approach needs to be adjusted for this very different economy.