Value Investing

Value investing is a style of investing which derives its fundamental basis in business ratios. It is a long-term investing method that takes advantage of short-term downturns whether industry or market wide. Upon recovery, the investor simply sells their investment and waits for another downturn.

Purchased 292.0560 Shares Wells Fargo Bank

With a tangible book value of approximately $33 per share and a current market price of $33.24 per share, the Banking Pool diversified its portfolio and purchased 292.056 shares of Wells Fargo Bank this morning. The company is due to report its quarter results later this week. 

Including a transaction fee of $1 per share, the total investment is $10,000. The market recovery price is set to $53.00 per share and it is anticipated this will be achieved within 18 months.

Purchased 43.2994 Shares Essex Property Trust

Essex Property Trust, Inc.

Today, the Value Investment Fund purchased a second tranche of Essex Property Trust. After calculating the intrinsic value of Essex Property Trust at $256, the REITs Pool allocated $10,000 for a second purchase of Essex once the price dipped below $230 per share. Today, 01/11/21 at 12:38 PM, the stock price dropped to $229.95.

Value Investment Fund Status Week 11 – Good Week

Week 11

During the week ending January 8, 2021, the Value Investment Fund expanded 1.3%. Whereas the DOW reported a stronger uptick of 1.5%. Again, exceptional growth for the fund is held in check due to the continued poor performance of the REIT Pool. The concerns about the ability of folks to pay rent during this lockdown period is holding the pool in check. Many institutional investors in these stocks are waiting for the 4th quarter reports; the preliminary reports are due out in two weeks.

At the beginning of the week, the Investment Fund’s status stood at $116,231 (see End of December 2020 report). On Friday, Union Pacific was sold at $215.17 as that particular stock soared that day. In total, Union Pacific had a 23.66% return in only 72 days. This was another successful full transaction. This transaction added $4,620 to the realized returns total of $9,177.38 including dividends earned of $1,122.12 in 79 days. This is tracking for a 42% annual return. The Investment Fund is still adhering to the expected return of at least 34% during 2021.

Intrinsic Value of Essex Property Trust

Essex Property Trust, Inc.

Intrinsic value of stock is a company’s realistic value per share at any given moment. Intrinsic value is not book value; it is the most likely dollar amount a reasonable person would pay for the underlying net assets. In most cases, an investor would include some value for the near-term future earnings of the investment; but the core amount in determining the intrinsic value of a share of stock is tied to the net assets at fair market value.

The intrinsic value formula is different for every sector of the economy and for the respective industries within that sector. Equity based real estate investment trusts (REITs) consist of six different types. One of the types of REITs are apartment complex based operations. In effect, they are apartment rentals. With real estate, specifically those in the home rental industry which includes apartments, condos, townhomes and traditional individual homes, intrinsic value is strongly tied to the fair market value of the rental properties less the assigned associated debt (mortgage). In addition, some value is included for future near-term earnings and the other assets on the balance sheet. It is really no different than how your traditional home rental operation would value their investment.

With Essex Property Trust, this REIT has been around for almost 30 years. It owns 246 apartment complexes with 60,272 units. There are an additional 1,853 units under construction. To determine intrinsic value, one would simply appraise all 246 complexes, determine the full fair market value and then deduct the total debt to get net assets value. Add to this value, the other assets on the books, get a full net assets value at fair market value. In addition, you would simply add about three years of profits. With this cumulative sum, divide by the number of shares and determine an approximate intrinsic value per share.

This appears relatively simple. For Essex, assume each unit can be sold for $350,000; seems like a reasonable value per unit. Total fair market value would approximate $21.1 Billion. The other assets on the books are equal to around $900 Million, thus total assets at fair market value would approximate $22 Billion. Total debt and current liabilities on the books are approximately $7.2 Billion. Once the liabilities are satisfied upon the sale of the units, the net remaining amount available to all shareholders results in $14.8 Billion. There are 67.5 Million shares outstanding. Thus, each share has a net worth of about $219 tied to net assets value at fair market value.

Currently, the company’s net operating income is just a little over $8 per share. Using three years of net income, the investor would add about $24 to the net assets value outcome to get total intrinsic value. Three years of net income is used as this would be a reasonable and normal time period to dispose of all the complexes, i.e. it would be the time period to negotiate an arm’s length transaction (fair and normal). Thus, Essex Property Trust’s intrinsic value is approximately $243 per share. 

Of course, there is more to it than this simple approach. But the core idea is there; the intrinsic value should be in the neighborhood of $243 per share. As a value investor, you should anticipate that the intrinsic value isn’t going to deviate greatly from this simple quick calculation. In effect, a value investor would expect the actual outcome to end up within 20% of this quick calculation. Thus, the final intrinsic value should end up in between $195 per share (20% less) and $292 per share (20% more). From Lesson 7, there is no definitive intrinsic value calculation for any stock. Intrinsic value has a range; the key for value investors is to narrow this range as much as possible in order to determine a reasonable intrinsic value for any potential stock investment. Ideally, getting the range down to plus or minus 3% is the goal. In effect, the final intrinsic value calculation is somewhere between the two given outcomes and the value investor’s goal is to have a high level of confidence with the final outcome. 

What is important here is that if you end up with a really conservative outcome (tending towards $195/share), it is likely the market price will never dip this low (the last time was in November 2014) thus eliminating opportunities for the value investor. If the end result is too high (tending towards $292/share), you end up with more opportunities but the end result with the investment is less gains from the respective buy/sell turnovers and therefore the overall return for a value investor decreases. In effect, it defeats the purpose of value investing which is to buy low and sell high. Thus, it is extremely important to walk through the exercise of calculating a reasonable intrinsic value that results in reduced risk and adequate opportunities to make buy and sell transactions assuring an excellent return for the portfolio, i.e. the pool of similar investments.

Given this, how do you determine a REIT’s intrinsic value to plus or minus 3%?

Sold Union Pacific – 23.66% Return in 72 Days

Value investing is about buying low and selling high. The investor creates a model to set buy/sell triggers and exercises this program with investmetns. Back on October 29, 2020, the Railways Pool of the club’s Value Investment Fund purchased 114.9557 shares of Union Pacific at $173.98 each including a $1 per share transaction cost. In that post, the sell point was set at $215.17 which occurred this morning in the market. Union Pacific actually cleared $221 at one point this morning. 

The fund’s preset sell, automatically sold when the price hit $215.17. The fund netted $214.17 per share after paying a $1 per share transaction fee.

The return on the investment is $40.19 per share as follows:

Value Investment Fund – Status on December 31, 2020

On November 30, 2020, the Investment Fund’s balance was $114,576.76. During the month of December, the DOW Jones Industrial Average increased 3.28% from 29,603 to 30,606. This club’s fund, increased 1.44%. The difference is directly associated with the REIT pool. That pool’s balance on November 30th was $68,019, thus it decreased .4%; thus it performed significantly poorly in comparison to the market as a whole. This is due to the long-term concern tied to real estate directly associated with the outcome of rents collectable due to COVID. Until their is greater confidence in the market for employment, REITs will most likely not perform well in the interim. Once that confidence comes back, REITs will soar in the market. For now, patience is an essential characteristic for value investors. The intrinsic value of the stock is such that there is sufficient safety of margin related to the respective investments. Look at the cost basis; the pool is still way ahead of the cost basis.

Value Investing – Industry Standards (Lesson 13)

Have you ever wondered how the measurement of length called a ‘meter’ came to be? It is simply the distance light travels in a given time period. The key isn’t the actual definition, it is whom dictates this time period of travel. Some authority states that this is the definition of a meter (also written as ‘metre’). It is currently the International Committee for Weights and Measures based out of France. It is an 18 person task group promoting uniformity with units of measurement. This committee is the authority.

This same principle of authority exists in business. Every industry has their own authority or set of principles promulgated by an agreed upon group of individuals or a leader within that group. For value investors, understanding the authority for the respective industries is essential to measuring success for each member company within the pool of potential investments. Once a value investor recognizes what is the standard of production or performance, it becomes easy to compare their respective investments and then equate this into financial value. There is a hierarchy of authority for all industries. In almost all cases, the number one authority is a governmental institution or law. Other levels of authority at the next level include academia, associations, journals, books, white papers and committees. The third level of authority include experts and company level affiliations. The final level of authority is the leader in the respective industry.

Each of the following sections explore these different levels of authority. In each section, there is an introduction to the various resources the value investor may wish to use when investigating their respective industry. The key to this lesson is to understand that higher levels of authority are the standard setters. Value investing is about having facts to support a buy/sell position with each member of the pool of investments. The stronger the authoritative position of the standard setter, the more accurate the buy/sell trigger points can be calculated.

Value Investing – Business Ratios (Lesson 12)

Business ratios are used to compare similar companies within the same industry. RULE #1: DO NOT USE BUSINESS RATIOS TO COMPARE COMPANIES AGAINST EACH OTHER IF THEY ARE IN DIFFERENT INDUSTRIES.

Business ratios are not perfect, they have their respective flaws and it is important for value investors to understand the algorithms used with business ratios. It is also important to note that business ratios can be easily manipulated and result in misleading outcomes. More importantly, business ratios only reflect current information and not long-term trends. Think of business ratios as comparable to a doctor acquiring your vitals upon your medical visit. The vitals only reflect the ‘then and now’ status of your medical condition. They do not reflect your lifetime nor trending condition. 

In effect, business ratios have a purpose, although limited. They are the best tools to compare similar companies within the same industry and typically the same market capitalization tier. Thus, a second rule to use with rule number one above; RULE #2: USE BUSINESS RATIOS TO COMPARE SIMILAR MARKET CAPITALIZATION COMPANIES WITHIN THE SAME INDUSTRY.

Because business ratios can be easily manipulated, it is important that users of business ratios have a full understanding of their respective formulas. RULE #3: BUSINESS RATIOS ARE NOT AN ABSOLUTE RESULT. They are merely indicators and that is all they are good for when interpreting their results. 

Even with the above limitations, business ratios are beneficial to investors as they are the best method of comparing existing or potential investments. Their results are not perfect, but they can indeed provide adequate confidence when making pertinent decisions about a companies current financial status. 

Value Investing – Key Performance Indicators (Lesson 11)

All of us use indicators everyday to help us manage our lives. These indicators assist us with making good decisions. This same concept exists with stock investments. There are several different indicators related to stock. Most of them are financial in nature and often summed up via business ratios. However, many of the top companies provide additional indicators. One of these additional groups of indicators are ‘key performance’ markers. In effect, they are production based bits of information that assist value investors in developing and validating a good buy/sell model for that particular company.

Performance indicators are different for each industry. For the value investor, understanding the respective industry along with their systems, processes and critical points are essential when evaluating the current stock price along with market reactions. It is important for the value investor to understand not only the quantitative results of performance, but the standard of performance to measure the actual outcome against. In most cases, performance indicators exist with sales, production, and marketing/advertising. The key to success is to incorporate all these different data points and create an impact factor with the company’s stock price.

The end goal of monitoring performance is to determine if the buy/sell model requires any update. It is a simple ‘Yes’ or ‘No’ decision. When creating a trend line of data, it is best to look at as much history as possible, the author suggests no less than five years; preferably the trend line should be greater than seven years. Analytical standards place more emphasis on recent outcomes in comparison against the more historical results. Value investors take a more conservative approach and use the average of the trend line to determine the ‘Yes’ or ‘No’ model update. The reasoning is simple, short-term results or near-term expectations should have little bearing on overall historical performance and the corresponding buy and sell triggers for a particular stock. Just because the recent performance is either elevated or depressed doesn’t indicate an ongoing trend. Recent performance may have been hampered or enhanced due to environmental or unusual conditions. Basing one’s decision on the most recent results is speculative and not a sound investment concept. Using the overall average is superior as it eliminates speculation.

Value Investment Fund Status Week 9 – No Change

During the week ending December 25, 2020, the Value Investment Fund expanded 1.6%. Whereas the DOW reported a slight uptick of .04%. The lack of action by the President to sign the relief bill passed by Congress greatly affected the markets as a whole. Both the S&P 500 and the 1500 Composite Index only marginally decreased, about .2% each.