Long-term Investing & Value-Investing: Any difference?

By Aaron Hee

16 February 2009 7 January 2010 (Revised)

Long-term investing and Value Investing. I aim to achieve a clear distinction between these two concepts in this article with some digression into other investment issues. Before its major difference struck me, I thought both were the same, that one is identical to another. After one particular event, I realised such misconception could lead to financial losssomething that you don't want to experience.

Lets get started by clarifying a core concept Value Investing and Long-term Investing are two different approach. However, long-term investing is a subset of value investing. The opposite, though is absolutely wrong, invalid and financially fatal.

What particular event brought me to discuss this issue? In Dec'08, I was back home in Malaysia. I tried seeking for capital from friends to invest on their behalf. One of my efforts led to discussion of my venture with my friend's dad - in order to gain approval from his dad for some capital. This gentleman is a successful businessman in his own rights. He has seen successes, booms and recessions (in other words, businesses collapsing) and how the stock market pushes and bullies investor in spite of whatever approach, strategies and methods that guides the investor.

During the discussion, I tried to convince him of my approach, explaining my method and fundamentals and techniques and so on, so forth. Based on experience alone, I am next to nothing compared to this successful businessman. You might find it stupid and irrational for me to go ahead with my investment and helping people to invest (or burning their money in your terms) given my major lack of experience. To compensate for this, I equipped myself with practical advice- established for more than half a century and practiced and proven by many well-known successful investors. Well, learning is one thing and doing is it is another. Cant deny that. But how wrong can I go if I am discerning and diligent in my education? Don't get me wrong- I am not implying that these methods are flawless. In fact, being an inexperience investor, my poor execution (hopefully it wouldnt happen) might tarnish the reputation of the advice.

From the very beginning, his responses and reactions to my ideas were filled with complete pessimism. Couldnt blame him. The market was off the cliff. This businessman was drowned

in sea of pessimism due to losses in his stockholdings, slowdown in his business and stories from his wealthy friends how bad they were doing. He was even adamant that fundamentals do not work in such bad times. To be honest, even during boom times or bull markets, fundamentals hardly remain intact. Market tends to deviate from fundamentals frequently. Those investors who made it big exploited this deviation by sticking close to their principles and a strong belief that fundamentals will remain fundamentals. He was adamant from the very beginning that what I am doing was big-time mistakes - both in investing in current market and trying to invest people's money without experience. I accept the latter part. I lack experience. But the former , it's rather subjective. Time will tell. From that very point onwards, I knew my chances of raising fresh capital is less than zero. At least through that discussion, I was enlightened in this aspect.

When someone invest for the long-term, the majority will say that this is a minimum-risk and wise investment since in the long-run markets will trend upwards. True to an extent. If you think this statement is correct, then continue reading.

When I was discussing my approach as long-term, he started explaining the flaws of fundamentals and long-term investment. He gave me real-life examples. He described some of his investments to me - his approach, his holdings. One particular holdings of his was bought because of interaction with a very senior executive of that company who reaffirmed him and the rest of the market of the bright prospects of the executive's company. Honestly, the only answer the executive can give, in summary is 'our company is on the right track and doing well-expect for more'. Who will actually provide a true and honest pros and cons comparison when trying to sell you and the rest something. With this, decision was made, bought the shares during boom time expecting to hold for the long term, came the market downturn, and saw his holding fall in value substantially, then started blaming that long-term investing does not work. Another approach that I could recognised was buying big, blue-chip companies because they tend to go up. Does this mean that blue chip firms will continue performing brilliantly for an indefinite time? It isnt wrong when you have done proper analysis, however, buying blue-chips because it tend to go up does not reflect proper investing. What's the lesson? Do not buy on what others say, buy based on your analysis be it a blue-chip or not. And, up market will eventually be followed by a down market. Nothing is permanent especially in the financial markets.

In the long run, yes, he might recoup his losses. But how long will that take? One thing he cannot recover - opportunity costs. Aha, time value of money. Relate to compounding and you can see the extent of losses actually incurred if the capital is wisely invested.

Long-term investing is only successful if you relate it too value investing. Value investing, in a nutshell is all about identifying deviations and discrepancy between price and value. Exploit it wisely and money starts snowballing into your pocket. How to exploit? Simple. Everyone does this. We buy when things are on sale. So, buy when something is cheap relative to the value you are getting in return. But the problem is this- it is difficult to define value of a company. It is not necessary to place specific figures on this value. After all, value is a subjective term and investing is a form of art. Take Benjamin Graham's analogy- you dont need a scale to tell if someone is overweight. In simple terms, profit by buying low and selling high. We all know this. Logical and sensible, isnt it? Yet, the opposite is often practiced. How could someone be so whacked out of his or her mind to buy high and sell low? One word emotions. That would be another topic of discussion sometime in the future.

The main idea is your entry point when purchasing a share. When it is overpriced, and you buy this company, you are expecting the market to go higher (recall tech bubble in at the beginning of the century). But heated markets will cool down or worse, things will start to collapse. So, your downside is way greater than your upside. There is still upside, but with minimum probability. Where as if you bought it at a lower price, or a discounted price to its fair value, your downside is lower since the company either has the potential to unlock its value or the market will gradually recognise and reward it with higher valuation. To make yourself feel better when things fall, or worse, collapse, you will start saying to yourself you are buying for the long-term.

Take this for example. Your share value falls by 50% from $100 to $50. In order to breakeven or coming back to your original position, you need to gain 100% of the current value of $50. Assuming the general market grows by 15% annually after this downturn (this is a very optimistic projection), you need 5 years to recoup your losses assuming you do not costaverage your losses. 5 years past and you only broke-even. So much for long-term investing. Again, relate this to compounding. Assuming after so many years you could not recover your loss of $50. Is your actual loss limited to $50? Not really. Factor in the opportunity costs of having the initial capital invested in bank. At a given interest rate of 3% per annum (again, this rate is extremely high given todays condition. This article was written sometime ago before the market was on its knee) compounded for 5 years, you will get $115.93 in Year 5. So there

is an additional loss of $15.93. If the capital was invested wisely, what would the outcome be? Assuming conservative returns of 8% per annum (ah, finally something which is achievable) compounded over 5 years, you will get $146.93 in Year 5. So, the loss actually widens substantially. The bigger the compounding factor, bigger the loss.

Although buying at discounted prices to intrinsic value is safe, this does not promise or guarantee returns or complete protection from losses. What it gives you is protection or in more technical terms, higher margin-of-safety - lowering your chances of losses, not eliminating it and increasing the potential for upside. The bigger the discount to its intrinsic value, bigger the margin-of-safety. However, be sensible. Troubled companies are usually selling at distressed price levels. When you buy it cheap, you are assuming high risk that the company could go bust, eventually losing your capital. Lots of courage and faith is needed to make such purchase. But courage is not enough a deep, thorough analysis and understanding of the situation is required. Without the second element, you are technically betting for an event to occur. That is gambling. Genting would be a much more entertaining place to be, not the stock market.

Do take note that I am not advocating against paying a premium for good companies. Some fundamentally strong companies deserve premium. Again, it is the amount of premium that the company deserves. Flash back to the tech bubble era. Take eBay. It was and is still a decent company. During the tech bubble, its premium was easily more than 2000% of its fair value despite having a business model that was not firmly established yet.

Still could not catch why long-term investing is value investing but not the opposite? You discover price-value discrepancy (value investing), buy, hold on to it (usually for the medium to long term) until it exceeds substantially its fair value then sell and you pocket a decent profit with little risk. Where as long-term investing, you might risk overpaying or buying a company at too high a price thus having little margin-of-safety to cushion your loss if the price falls.

This is the insight I got from the discussion with that businessman. No capital, but at least a big lesson. I felt intimidated and discouraged with all his 'advice'. This sets a challenge for me to prove to him and others in the community that this method actually works- this old school method actually works! Many people have done this. They practice value investing day in, day out and made a bundle for themselves and their investors. It is a proven method, yet

many people overlooked and shrugged this concept aside. Is it human nature that people want fast and easy money?

Value investing is what I practice and investing for the long term comes with it. I eat what I cook. My entire faith and trust is dedicated to this concept. My entire net worth (life time savings, earnings, red packets etc.) is invested in my informal investment partnership with these fundamentals guiding me. At least I managed to convince some people to invest in my beliefs.

There are definitely flaws in this concept and also my discussion above. For one, there is too much for me to go into detail. Also, it might be purely my fault and flaw to express my thoughts filled with ambiguities. Point it out, let me know, give me a chance to correct or defend myself and if all fail, I will admit that I am wrong and will rethink my position.

Hope this has enriched you or at least, make you THINK about investing.

Remember, dont speculate. Invest.