Ekta Kochar | MBA | December 18, 2013

Value Investing 2013

Value Investing 2013

Value Investing
Ekta Kochar, Auro University

ABSTRACT
At present situation it is difficult for an investor to earn good amount of return from their investment. This paper aims in giving an idea about value investing and how one should select stocks for value investing. Great investors like Warren Buffet follows this method to earn profit from their investment. Value investment have various benefits but there are even mistakes which are made while doing value investing. Thus a good investor should not lead themselves to wrong way. [Key Words: Value Investment, Stocks, market efficiency, financial statements, assets]

1.

INTRODUCTION
1.1. Meaning of Value Investing

Value investing is a style of investing developed in the early 30s by Ben Graham at Columbia University. It involves a three step process even though most people believe the process is limited to only the first step. First, identify possibly undervalued stocks by choosing stocks with low price-to-earnings (P/E), price-to-book (P/B) or other valuation related metrics. Second, value in depth the stocks that pass the screening process to estimate their intrinsic value. Third, make an investment decision to buy only if the stock price is below the intrinsic value by a predetermined margin of safety value investors

1|P A G E

Value Investing 2013

are very careful of valuation risk, which is paying too much. Value investors are contrarian (bottom up) stock pickers with long term perspective. Benjamin Graham will always be remembered as the father of value investing. Graham was just as concerned with the quality of a firms assets as he was with the price that one had to pay to purchase them. According to Graham, an equity investor should apply a set of standards to each [stock] purchase, to make sure that he obtains a minimum of quality in the past performance and current financial position of the company, and also a minimum of quantity in terms of earnings and assets per dollar of price(Graham 1973, pp. 183). Of the seven quality and quantity criteria that Graham suggested a firm should meet for inclusion in an investors portfolio, five were directly concerned with firm quality, while only two were related to valuation. Warren Buffentt the father of financial management We think the very term value investing is redundant. What is investing if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value in the hope that it can soon be sold for a still-higher price should be labelled speculation (which is neither illegal, immoral nor in our view financially fattening). Whether appropriate or not, the term value investing is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to

2|P A G E

Value Investing 2013

whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield are in no way inconsistent with a value purchase.

1.2. Who are Value Investors

Value investors in simply can be defined as the person who simply invest in low P/E stocks. In other words value investors can be defined as those investors who are interested in buying stocks for less than what they are worth. But that is too broad a denition since you could potentially categorize most active investors as value investors on this basis. After all, growth investors also want to buy stocks for less than what they are worth. Thus If a person is a value investor, then he should make his investment judgments, based upon the value of assets in place and consider growth assets to be speculative and inherently an unreliable basis for investing. Put bluntly, if you are a value investor, you want to buy a business only if it trades at less than the value of the assets in place and view growth, if it happens, as icing on the cake.

2.

LITERATURE REVIEW:

Value investing is a broader concept. There are various thoughts of various men on this topic. Investors and value investing teachers like Graham, Buffett, Munger, Howard Marks, and Prof. Sanjay Bakshi have wrote various papers and books on value investing.

3|P A G E

Value Investing 2013

Value investing is a long-accepted and well-known investment style among US investors. It is well documented that the value style has performed better than the growth style in the United States over the longer term. We asked if value investing is as successful outside of the US markets and found supporting evidence that value investing is indeed a viable investment approach internationally. As non-US equity markets have developed and become increasingly efcient, the same broadly accepted principles of value investing that have been proven to outperform other investment styles over the long term can be applied to international equities with the same rigor and success that has been experienced broadly in the US equity markets since the 1930s. In fact, a Pyramis Global Advisors study on value investing proves that non-US value investing actually has a superior historical return prot relative to US value investing. This paper examines whether a Simple accounting-based fundamental analysis strategy, when applied to a broad portfolio of high book-to-market firms, can shift the distribution of returns earned by an investor. Within the Portfolio of high BM firms, the benefits to financial statement analysis are concentrated in small and medium-sized firms, companies with low share turnover, and firms with no analyst following, yet this superior performance is not dependent on purchasing firms with low share prices. A positive relationship between the sign of the initial historical information and both future firm performance and subsequent quarterly earnings announcement reactions suggests that the market initially underreacts to the historical information. In particular, one-sixth of the annual return difference between exalted strong and weak firms is earned over the four three-day periods surrounding.

4|P A G E

Value Investing 2013

Value investing is on average quite profitable, but the quality metrics Graham employed have not reliably forecast relative stock performance. The last decade has seen resurgent interest, however, in quality investing. Quality is often viewed as an attractive alternative to traditional growth, which performed terribly during and after the dot-com bust. Its leading industry proponents include GMOs Jeremy Grantham, whose high quality indicators of high return, stable return, and low debt have shaped the design of MSCIs Quality Indices, and Joel Greenblatt, whose Little Book that Beats the Market has encouraged a generation of value investors to pay attention to capital productivity, measured by return on invested capital, in addition to valuations. There has also been increased interest in incorporating academic measures of quality into value strategies. Black Rock, the earliest adopter (when still BGI) of Sloans (1996) accruals-based measure of earnings quality, is currently promoting the benefits of integrating earnings quality into global equities strategies (Kozlov and Petajisto, 2013). Piotroski and So (2012) argue that strategies formed jointly on valuations and another accounting based measure of financial strength, the Piotroskis (2000) F-score (which uses both Sloans accruals and aspects of Granthams quality among its nine components), have dramatically outperformed traditional value strategies. Societe General has appropriated Piotroskis F-score (without attribution) as the primary screen it employs when constructing its Global Quality Income Index, launched in 2012 (Lapthorne et. al., 2012). Novy-Marx (2013) finds that a simpler quality measure, gross profitability (revenues minus cost of goods sold, scaled by assets), has as much power predicting stock returns as traditional value metrics. Strategies based on gross profitability are highly negatively correlated with strategies based on price signals,
5|P A G E

Value Investing 2013

making them particularly attractive to traditional value investors. Novy-Marxs results have influenced the design of both DFAs growth funds and AQR Capital Managements core equity funds. DFA believes that the research breakthrough in this case is not the discovery of expected profitability as a dimension of expected returns p er se [But] the discovery of reasonable proxies for expected profitability, which allow us to use profitability as another dimension of expected returns in the creation of investment solutions (Chi and Fogdall, 2012). Value investors generally characterize themselves as the grown-ups in the investment world, unsaid by perceptions or momentum, and driven by fundamentals. While this may be true, at least in the abstract, there are at least three distinct strands of value investing. The first, passive value investing, is built around screening for stocks that meet specific characteristics low multiples of earnings or book value, high returns on projects and low risk and can be traced back to Ben Grahams books on security analysis. The second, contrarian investing, requires investing in companies that are down on their luck and in the market. The third, activist value investing, involves taking large positions in poorly managed and low valued companies and making money from turning them around. While value investing looks impressive on paper, the performance of value investors, as a whole, is no better than that of less sensible investors who chose other investment philosophies and strategies. We examine explanations for why "active" value investing may not provide the promised payoffs. A portfolio strategy that select stocks with strong value characteristics, e.g. book to market ratio, has on average outperformed overall market and growth stocks. For

6|P A G E

Value Investing 2013

example, one dollar invested in large value stocks in 1965 was worth 177 dollars at the end of 2005. A similar investment in the overall market would be worth only 57 dollars. The one dollar investment in small value stocks was worth 919 dollars! This site will briefly summarize the findings in academic papers about value oriented stock selection methods from the past two decades. The papers will review the success of the value strategies in the US data in small and large stocks and international stock data as well. The information provided here is meant to provide an entry point to the empirical value studies past and present.

3.

OBJECTIVE:

The objective of this paper is to study To identify from literature the various views of investors about value investing The five pillars used for success as an investors How value investing is beneficial for investors Various valuable resources required for value investing Methods used for value investing

4. RESEARCH METHODOLOGY:
4.1. Research Design
"Research design is the plan, structure and strategy of investigation conceived so as to obtain answer to research question and to control variance." From definition it is evident

7|P A G E

Value Investing 2013

that research design is more or less a blueprint of research. At the outset may be noted that there are several ways of studying and tackling a problem. There is no signal perfect design. The research design can be classified in to true broad categories:

Exploratory
Exploratory research is focus on the discovery of ideas. Exploratory research is carried out to define problems and developed hypothesis to test later. An exploratory study is generally based on the secondary data that are reading available. It does not have to change his focus of direction, depending on the availability of new ideas and relationship among variables.

Descriptive
Descriptive studies are undertaken in many circumstances. Descriptive studies can be complex, determining a high degree of scientific skill on the part of the researcher.

Casual
Casual research helps in determined cause and effect relationship between two or more variables. The present study seeks to find out the determinants of stress among teachers. Analysis was conducted to determine the result of the research. Thus, the research design chosen by me is descriptive in nature.

8|P A G E

Value Investing 2013

4.2. Time and Place of study

The study was conducted at AURO University, which is located in Surat, Gujarat, in the month of December 2013.

4.3.

Method of data collection:

The data collected is a secondary data. The information in this paper is taken an analysed form various research paper and books written by Graham, Buffett, Munger, Howard Marks, Prof. Sanjay Bakshi, Joseph D. Piotroski, and Aswath Damodaran.

5.

RESEARCH FINDINGS:
5.1. The Five Pillars Of Success As An Investor

According to Rohit Chauhan, there are five pillars of investing that can lead to successful and value investing. They are

9|P A G E

Value Investing 2013

Pillar 1: The Business

A stock is a share in a business. A stock is not a piece of paper like speculators and traders treat it as. A stock represents part ownership in a business. Benjamin Graham, the father of value investing, wrote that investment is most intelligent when it is most business like.

Pillar 2: Circle of competence

As an investor, one must invest in a company whose business he can understand with ease. Great investors have become great by following this very principle of circle of competence.

10 | P A G E

Value Investing 2013

Pillar 3: Intrinsic value

Price is what you pay, value is what you receive, goes the famous saying. We employ this in everything we buy. And we almost never pay a price that we believe is higher than the value a thing provides. But this principle is rarely used when it comes to investing in the stock markets. Value is rarely considered a determinant of the price most people pay for stocks they buy.

Pillar 4: Mr. Market

Stock prices fluctuate, sometimes wildly. Some of these fluctuations arent bad! In fact, these provide the sensible, value investor a good hunting ground to identify quality stocks at throwaway prices. As Buffett once said, Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.

Pillar 5: Margin of safety

These are considered the three most important words in investing. Margin of safety is simply the difference between the intrinsic value of a stock (and the core value of its underlying business) and its market price. It suggests that one should buy a stock only when its intrinsic value is worth more than its price in the stock market. The key advantage of using margin of safety while investing is that it minimizes the chances of permanent loss of capital. Value Investing for Smart People will explain you in a simple manner how you can include the margin of safety principle in your investing to preserve your capital.

11 | P A G E

Value Investing 2013

5.2. The Different Faces of Value Investing:

Passive Screeners: Following in the Ben Graham tradition, you screen for stocks that have characteristics that you believe identify undervalued stocks. You are hoping to nd market mistakes through the screens. Ben Graham Screens: 1. PE of the stock has to be less than the inverse of the yield on AAA Corporate Bonds: 2. PE of the stock has to less than 40% of the average PE over the last 5 years. 3. Dividend Yield > Two-thirds of the AAA Corporate Bond Yield 4. Price < Two-thirds of Book Value 5. Price < Two-thirds of Net Current Assets 6. Debt-Equity Ratio (Book Value) has to be less than one. 7. Current Assets > Twice Current Liabilities 8. Debt < Twice Net Current Assets 9. Historical Growth in EPS (over last 10 years) > 7% 10. No more than two years of negative earnings over the previous ten years. Contrarian Investors: These are investors who invest in companies that others have given up on, either because they have done badly in the past or because their future prospects look bleak. You are implicitly assuming that markets over react.

12 | P A G E

Value Investing 2013

Activist Value Investors: These are investors who invest in poorly managed and poorly run rms but then try to change the way the companies are run.

5.3. The advantages of value investing:

Value investing, for the most part, ignores current trends in favour of company fundamentals, and has many advantages over other forms of stock market investing, including: 1. Value investing is like buying stocks at a discount, and those are the stocks that have the greatest potential to outperform the market. 2. It stacks the long-term in the investors favor. 3. Value investing is low maintenancethere is no need to monitor stock performance dayto-day. 4. Theyre less affected by short term drops in the stock market than more trendy stocks. 5. You wont become a trader with value stocks, and therefore wont be faced with paying the fees that traders typically pay. 6. Value investment even takes advantage of market fluctuation- the basic principal is simple: the stock market and the individual stocks that make up the stock market have always bounced back and forth from overvalued to undervalued to overvalued, over and over again 7. Theres no need to adjust your stock strategy with every shift in the stock market. Because of all of the above, value stocks make for restful nightsa lot of them. Because value investing is so focused on the long-term, its perfectly suited for retirement investing.
13 | P A G E

Value Investing 2013

5.4. How to choose a stock for value investing

Mr. Graham details seven criteria that differentiate between a bargain stock and a stock that is priced too high. Included in his criteria are: 1. Low price to book value ratio 2. Low price to earnings ratio 3. Strong balance sheet 4. Some earnings growth 5. No earnings deficits during the past five years 6. Currently paying a dividend 7. Future outlook for the company must be positive (This eliminates banks and homebuilders for now.)

5.4 Is value investing worth it?

Value investing is a time honored investment strategy and is the hallmark of many successful long-term investors including Warren Buffet. The results speak for

themselves. The value investor makes solid stock picks based on the strength of the underlying companies and is less subject to the ups and downs of the general stock market. Because many value stocks have already come through periods of decline, they tend to fall less than other stocks that may have ridden a bull market to the top. And while value stocks may not always be the high flyers in the latest bull market run, when they do finally take off, you may get greater gains from having bought when no one else

14 | P A G E

Value Investing 2013

was paying attention. Buy on bad news, sell on good news is at the heart of value investing. Is it worth it? Most definitely yes.

6. CONCLUSION:
At present the market is very fluctuating and for an investors it is very difficult to make a value investment. So to make a value investment there are various gurus who have given various mantras for value investing. Among all Ben Graham is said as the father of value investing. He was the inventor of this method. According to him value investing comes in many stripes. First, there are the screeners, who we view as the direct descendants of the Ben Graham School of Investing. They look for stocks that trade at low multiples of earnings, book value or revenues, and argue that these stocks can earn excess returns over long periods. It is not clear whether these excess returns are truly abnormal returns, rewards for having a long time horizon or just the appropriate rewards for risk that we have not adequately measured. Second, there are contrarian value investors, who take positions in companies that have done badly in terms of stock prices and/or have acquired reputations as poorly managed or run companies. They are playing the expectations game, arguing that it is far easier for firms such as these to beat market expectations than firms that are viewed as successful firms. Finally, there are activist investors who take positions in undervalued and/or badly managed companies and by virtue of their holdings are able to force changes in corporate policy or management that unlock this value. What, if anything, ties all of these different strands of value investing together? In all of its forms, the common theme of value investing is that firms that are out of favour with

15 | P A G E

Value Investing 2013

the market, either because of their own performance or because the sector that they are in is in trouble, can be good investments.

7.

REFFERENCES:
Value Investing: A Basic Guide - Cabot Heritage

In-text: (Cabot.net, 2013) Bibliography: Cabot.net. 2013. Value Investing: A Basic Guide - Cabot Heritage. [online] Available at: http://www.cabot.net/Content/Education/Value-Stocks/Guide-to-Value-Investing.aspx [Accessed: 18 Dec 2013].

Value Investing Resources

In-text: (csinvesting, 2013) Bibliography: csinvesting. 2013. Value Investing Resources. [online] Available at: http://csinvesting.org/valueinvesting-resources/ [Accessed: 18 Dec 2013].

Piotroski, J.

Value investing: the historical method

In-text: (Piotroski, 2013) Bibliography: Piotroski, J. 2013. Untitled. [online] Available at: 2013. . [ONLINE] Available at: http://www.chicagobooth.edu/~/media/FE874EE65F624AAEBD0166B1974FD74D.pdf. [Accessed 18 December 2013]. [Accessed: 18 Dec 2013].

. 2013. . [ONLINE] Available at:http://www.bengrahaminvesting.ca/Research/Papers/Value_Investing_The_Use_of_Hi storical_Financial_Statement_Information.pdf. [Accessed 18 December 2013]. Graham B (2003) The Intelligent Investor. Revised Edition, Harper Collins, New York. Basu S (1977) Investment Performance of Common Stocks in Relation to Their Price to earnings Ratios: A Test of the Efficient Market Hypothesis. Journal of Finance 32: 663-682. Fama EF, French KR (1992) The Cross Section of Expected Stock Returns. Journal of Finance 47: 427-465. Fama EF, French KR (1993) Common Risk Factors in the Returns on Stocks and Bonds. Journal of Financial Economics 33: 3-56 5. Fama EF, French KR (1998) Value versus Growth: The International Evidence.

16 | P A G E

Value Investing 2013

Journal of Finance 53: 1975-1999. Lakonishok J, Shleifer A, Vishny RW (1994) Contrarian Investment, Extrapolation and Risk. Journal of Finance 49: 1541-1578. Chan LKC, Lakonishok J (2004) Value and Growth Investing: Review and Update. Financial Analysts Journal 60: 71-84. Athanassakos G (2009) Value vs. Growth Stock Returns and the Value Premium: The Canadian Experience 1985-2005. Canadian Journal of administrative Studies 26: 109121. Athanassakos G (2011) The Performance, Pervasiveness and Determinants of Value Premium in Different US Exchanges: 1986-2006. Journal of Investment Management 9: 33-73. Athanassakos G (2011) Do Value Investors Add Value? Journal of Investing 20: 86-100. Cassidy J (2009) How Markets Fail: The Logic of Economic Calamities.Viking Canada, Penguin Group, Toronto, Canada.\ Greenwald BCN, Kahn J, Sonkin PD, Van Biema M (2001) Value Investing: From Graham to Buffett and Beyond. Wiley Finance, John Wiley & Sons, Inc., Hoboken, NJ, USA. Athanassakos G (2008) Seasonal Patterns in Canadian Financial Markets and the Impact of Professional Portfolio Rebalancing: Evidence of Profitable Opportunities. Journal of Financial and Economic Practice 9: 73-96.

17 | P A G E