Value Investing

FAMA French Three factors

DFA Future strategy
What is Value investing
• If you are investing in low P/E or P/B ratio you are a value investor
• Used to classify mutual fund in value and growth category
• If you want to buy stock for less that what is their worth
• Value of a firm = Value from existing asset in place + Expected value
created by the future investment
• As a value investor you would want to by some thing less than the
value of the existing asset in place
• View growth, if it happens, as icing on the cake
Few heuristics of the value investing
Ben Graham 10 rules
Cheap
1. Based on earning
• PE of the stock has to be less than the inverse of the yield on AAA Corporate Bonds
• Without assuming any growth STOCK should give me higher return than corporate bond
• PE of the stock has to less than 40% of the average PE over the last 5 years.
• Stock is trading cheap than its historical valuation
• Price < Two-thirds of Net Current Assets
2. Based on assets
• Price < 2/3 of tangible book value per share
• What would be the value of the firm, if it gets liquidated today
Clean measure of value
1. Based on Cash flow
• Dividend Yield > 2/3 of the AAA Corporate Bond Yield
• Company is passing me cash flow comparable to corporate bond yield
• Is high dividend yield sustainable (FCFE/ P)
• Has company entered the low growth phase
• Tax
2. Based on Revenue (P/S ratio)
• There is not much historical evidence regarding that
• Valuation of the flipkart
• Leverage
• Profit margin
 Possible Risk Value
Investor

• Although
  historically lower P/B stocks
have given higher returns
• But according to FAMA it’s a measure
of risk, because your growth has
deteriorated, you might run out of
business

• Over reaction and under reaction

• Value investor would argue that source
of risk is coming from higher value of
growth opportunities that market is
factoring, because its uncertain
It should have stable profitable business with
the modest growth
• However, we need to remove firm that is in the declining face
• Historical Growth in EPS (over last 10 years) 7%
• No more than two years of negative earnings over the previous ten years.
• High quality growth: ROE should be higher
It is not a risky investment
• Liquidity risk: Current Assets > Twice Current Liabilities
• Default risk:
• Debt-Equity Ratio (Book Value) has to be less than one
• Debt < Twice Net Current Assets
• Systematic Risk: Beta
• Standard deviation
• Sector risk
Buffet’s addition
• MOAT: Company should have competitive advantage
• Barriers to entry

• It should have credible management

• Invest in the business that you understand
• Less information asymmetry
Can you get such stocks
• Screener.in
Contrarian Value investing
• Market overreact to the news, especially to the bad news
• Richard Thaler:
• Winner portfolio: Top 35 stock who went up the most in the last 30 year
• Loser portfolio: Bottom 35 stock who went down the most in the last 30 year
Greedy when everyone is fearful and fearful
when everyone is greedy
• 2nd round of Investment in GEICKO by Berkshire
• Investing in Goldman Sachs just after the Lehman brothers file for
bankruptcy
Lesson learnt
Spice Jet
https://
www.livemint.com/Companies/T2BOBSwziSYSnEDPMJ2xEM/The-SpiceJet-turnaround-story-and-how-
it-became-worlds-best.html
Spice jet
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Value Investing and DCF
• 

• as a measure of risk
• Macroeconomic risk
• Margin of safety as an alternative of beta
• Value is not static and sensitive to the information