Value Investing – Holistic Approach (Lesson 4)
“The man who moves a mountain begins by carrying away small stones… It does not matter how slowly you go so long as you do not stop”.
Proper planning and preparation prevents piss-poor performance, an old military adage fits well the systematic approach value investing takes. By conducting modeling backed by financial metrics, value investors set buy and sell points for respective stocks. The buy and sell points are actually percentage discounts and recovery points of a particular investment. This allows the investment’s actual market share price to fluctuate to any extent and it is of no concern to the value investor. Once the market price crosses the respective threshold of either the buy or sell preset price, the transaction is automatically generated.
To illustrate, assume ABC Company’s most recent high in the stock market was $147.65. ABC Company is a member of a pool of similar investments, i.e. same industry, financial size, product and processes. The value investor did all the preparation by determining intrinsic values for each company in the pool, creating the financial metrics and reviewed key performance indicators to create each member’s respective discount and sell triggers. For ABC Company, the value investor determined that a 12% discount on any prior peak warrants a buy of the respective stock. In addition, the value investor determined it was best to sell the stock once the stock price recovered to 101% of the prior peak price. For ABC, the discount buy point is 88% of the prior peak or $129.93. Once the market’s share price reached $149.13 (101% of $147.65), the stock is sold.
The value investor creates computer orders for the respective values and the number of shares to buy and an equal corresponding sell order.
ABC’s stock fluctuates over four months around $139. Suddenly, Congress enacts a law requiring those in this industry to modify their facilities to include additional environmental controls. ABC’s stock suddenly drops to $127.44. As the stock slid past $129.93 the computer order at the brokerage automatically bought the respective number of shares or pool allowance. Over the next five months, the stock slowly recovers and finally hits $150/share in the market. At $149.13, the computer order automatically sold the stock. The value investor earned a gain of $19.20 per share. Since the invested amount was $129.93, the respected return on the investment equaled 14.78%. However, it took five months, thus the effective annual return was 35%.
Even if it took the stock nine months to recover, the effective annual return still exceeded 19% which is an excellent return on one’s investment.
This case is similar to all value investment transactions. There are several underlying elements that make value investing so successful. Value investors cover all the respective elements
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