(11-05-2014, 11:45 PM)CigarButts Wrote: [ -> ]Hi Guys, I am new around here. Have been in the trading scene for 2 years and did not do well in trading. Felt I was not suitable for it and decided to do passive investing instead one year ago.
Recently went for a free course which taught us how to value companies in the context of "Buying the assets and get the business for free". The way of calculation was to use the (Cash + properties - Total Liabilities ) / number of shares to get the price. If this price is below the current share price, then there is a chance this stock is undervalued. There are 3 more criterias.
1) Free cash flow for the past 3 years
2) PE ratio cannot be too high
3) Last one I can't really remember.
As I am quite new in value investing, can the old birds advice on this form of valuation? They did mention it is quite similar to an investor called Walter Schloss. Thanks.
Will just be blunt here. One of the problems with public seminar-style finance 'education' is that they are just embellished garbage that has not much real value to the student. Value investing itself is a behemoth, and the seminars usually have no pedagogy for a proper educational efficacy.
There's an old idiom which goes "better untaught than ill-taught", and I think that it'll be good to follow that advice. Investing requires knowledge beyond what has established in formal financial academia, and works best if you have as wide a knowledge as possible.
Before you hop onto the works of Graham, it'll be good to consider to have an understanding (if you don't already have) on:
1. The basics of micro and macro economics
2. The history of financial markets (bubbles etc.)
3. Current Affairs (to due interconnectedness of economies)
4. Accounting Principles
5. Nature of different businesses
The above mentioned "criteria" by the course on buying an "undervalued" stock is simply arbitrary. Book value/NAV seldom tell you anything about the business, unless you bother about the business going bankrupt and you are interested in how much money you will be getting back on your buck.
Let me quote Graham in his Security Analysis:
"Some time ago intrinsic value (in the case of a common stock) was thought to be about the same thing as “book value,” i.e., it was equal to the net assets of the business, fairly priced. This view of intrinsic value was quite definite, but it proved almost worthless as a practical matter because
neither the average earnings nor the average market price evinced any tendency to be governed by the book value."
(From Chapt 1: THE SCOPE AND LIMITATIONS OF SECURITY analYSIS. THE CONCEPT OF INTRINSIC VALUE; Examples of Analytical Judgement)
Here are further concerns of the criteria:
1. Cash flow indicates the
quality of earnings. It is regarded for prudence sake, but it doesn't tell you whether or not a business is going to be prosperous or not.
2. PE ratio is relative to growth. A company with a higher growth potential usually has higher PE. Firms from different industries have different PE levels as well. Construction firms usually have a lower PE compared to a tech stock, and that doesn't mean the construction firm is a better buy than the tech stock, ceteris paribus.
3. DE ratio is almost also relative and absolutely pointless if an arbitrary figure is ascribed to it. Business from different industries require different level of gearing. Construction firms usually require a great deal of leverage, and certain business (e.g. retail) can do without gearing at all. The point here is comparison with the industry average and make a personal judgement to see if the level of debt is prudent for that kind of business.
All the "criteria" pointed out in the course point to 1 direction:
A "safe" investment (quotation marks used deliberately)
It doesn't tell you anything about earnings, ROE, and all the different segments of a business that are extremely important (marketing, branding, employee management, expansion strategies etc. etc.). If the steps as of the seminar are followed, all that you're buying is the assets of the firm. A firm which falls into the said criteria can be something like Noel Gifts International -- though not a bad buy, not exactly a good buy either.
Also, there're a lot of books recommended here which are good books. But I implore a beginner to spare no cost (in time and effort) to educate himself on the very basics first. Investing is huge work. Effort must be in place. The best way of course is to enrol yourself in a business course, but self-education can work too. I must stress investing is an uphill battle for the layperson, and sometimes it is actually better to just put your money in index funds than to go through all these troubles at all.
*
"The fool and his money are soon parted."
-- Old English Proverb