Those new to the value investment philosophy typically begin to analyze companies that more often than not focus on ideal scenarios to identify current market value stock prices.
Unfortunately as we know ideal doesn't come along very often. Investments can not simply be put in this box or that box for analytical purposes. This is why the more savvy investors adapt their strategies to overcome the inevitable variants from one company to the next.
Price speculation is a gamble
The quality of a business or company will have an underlying contribution to your analysis and decision making. Attractive prices may not be evidence enough that an investment presents you with any value in the short-term and over the long-term. In fact if you make your selections based on an attractive price point alone, then you are more than likely speculating in anticipation of good fortune.
Thankfully, the value investment philosophy we use here at NaviCom International Investment helps you to avoid the need of speculation. Instead we continue to show our members that there is a more certain, guaranteed way of identifying value in their investment decision process.
Identifying value in great companies
At the heart of each value investment you make will be a definitive criteria that separates the companies you want to include in your portfolio from those you are happy to leave for the masses.
One important section of your analysis will be the identification of a criteria that is consistent to the large majority of value driven businesses and ideal investment scenarios. When you are looking at potential ideal scenarios focus your analysis on companies that fit within the four assessment sections of Business, Management, Financials and Valuation.
This is what we believe a company like that should look like:
Aim for a business that you can easily understand. There is no point looking at companies that you don't understand or can see how they generate their income. Being knowledgeable about a company is exceptionally important, you need to know what challenges it is likely to come up against and how it is structured to grow. The company has to be competitive, with a business model that can maintain an advantage over its rivals and be able to scale up considerably or your prospects for growth will be severely diluted.
Management & leadership
You need to look for a management team that is in line with the interests of the shareholders while showing excellent capital allocation practices.
When you have a CEO and management team that is inline with its shareholders you have a big advantage over companies that are at odds with their shareholders.
Along with its excellent capital allocation practices, that shows the company knows where it is going and will be effective at investing for long-term growth.
You need to be looking for a company that has a track record for consistently producing revenue and profits. It will have an exceptionally good balance sheet that can demonstrate a high cash flow aligned to low debt. At a bare minimum the company should be financially strong with no risk of external creditors chipping in to reduce the pot. There should be a good return on investment that shows its investors they are proficient at growing their investments.
When we are looking for great businesses we are always looking for the value. We will aim to buy at a slightly undervalued figure but you will often be looking at a fair value figure. Great businesses are rarely undervalued even in the event of a crash. More often than not they hold their own or maybe take a slight hit which they generally recover from very quickly and head back on an upward trend.
A company that satisfies all four section requirements is a great company, it will demonstrate hard evidence of past success and its future looks foreseeable. They are however few and far between so if you see them at a good price run and get your cheque book out.
Fair companies do not offer value
Generally though what you see is a fair company. A fair comapny's structure might not be quite as sound as a great company and probably fits into the following categories;
It's product or service can not maintain a competitive advantage
We see a lot of companies, particularly in the tech industry, whose stock price progresses at a rapid rate of growth. Identifying these companies during the growth boom can no doubt reward investors, but there is a lot of luck involved in picking a stock whose chances of long-term survival are low.
Unless the product or service is supported with a competitive advantage then the growth boom will be short lived. Being able to predict the peak of this boom is nothing short of guess work and does not fit with a long-term value perspective.
Weak capital structure
The financial structure of a fair company may make sense as the economic cycle remains stable. Do not be fooled into thinking that whilst a company appears to finically sound in the present that it will be able to show the same level of quality through unfavourable conditions.
Companies who are able to strongly capitalize on the issue of debt during buoyant times are most likely to struggle during times of market uncertainty. Whilst the good times are great and dividends are paid on top of rising prices, the bad times invariably crash.
The value investment philosophy is there to help you to capitalize on the good times and to preserve these gains during less favourable periods. After all what good is it if your portfolio advances 20% during a bull period but crashes 45% during a bear? Wouldn't your life be less stressful if that same bull-to-bear ratio was 14% up and 3% down?
Much is reported of management malpractice is pursuit of increasing shareholder value. Call it greed, an ego boost or downright irresponsible. Which ever way you look at it, if management are overly ambitious they are gambling with shareholder value.
In this case, ask yourself, if management is actually looking out for the wellbeing of their shareholders? Is such an aggressive approach really necessary?
Value your investment perspective
At NaviCom International Investment we categorize our perspective intro three different sections: Foreseeable, significant situations and asset plays. Each category has to be analyzed under a different light. By continuing to focus on the financials and the other three assessment sections, you will still be looking for a company that can fulfil certain criteria including a consistent ROI (return on investment).
There are still and always will be diamonds in the rough. To determine whether the current market value stock price of a company fits your value investment perspective, a good guide is to settle on a 55% margin of safety from its intrinsic value. You are aiming to buy cheap and make a fair bit of profit when the stock starts to climb again.