At The Root Of A Value Investment Philosophy – Chapter 7

We continue with our Margin Of Safety Book Summary and we are at chapter 7 – at the root of a value investment philosophy.

Good day fellow investors we continue with our summary of the best book on investing out there and today we touch on chapter 7 the core of a value investment philosophy thus discussing risk other topics are a bottom-up strategy absolute versus relative performance everyone is focused relative instead of focusing on the absolute investment performance i believe that

Over the next decade this will matter much more and over the last 15 years this was the only thing that matters because risk was just dissolved by the fed now that risk is again a big factor again value investing will matter more and we have to focus on what can go wrong first which is even more important than what can go right while with investors everyone focuses

On just what can go right let’s start immediately with bottom up investing which is opposite to the usual top-down approach when it comes to investing everyone is talking now about inflation it was the hot thing to do to get exposure to commodities of course that was the wrong thing to do last year now when it is again more interesting now nobody cares but then

The discussion is will the fed hike or where to hide if the fed hikes and the problem is that even if you are correct on the macro picture whether you know that there will be a great era of world peace and stability or world war iii if you are correct on the impact of this on bonds yields industries stocks and you also have to be correct at the right price before

Other people are correct on the macro so great example was commodities last year those were high everyone was buying the them but only those that bought them in 2020 were right and those that bought too late were wrong and lost a lot of money that is the problem with the top down approach you are not buying based on value but on concept team and trend and then you

Must also consider the expectations of others the valuation and the price paid when it comes to this which complicates a lot the investment easiest and strategy it is much simpler to take the opposite approach which is the value investing approach a bottom up approach so fundamental analysis one by one your investment opportunities and then sooner or later you will

Find something that fits you it is much easier to implement you focus on the business not on what the fed does actually you say whatever the fed does i am okay when it comes to that investment but sven what if the fed hikes well if the fan hikes that happens but i will get my dividends i will reinvest at lower prices and i have to buy at a margin of safety that

We discussed last chapter so that no matter what the fed does i am protected always keep in mind that when you’re investing margin of safety and until you find what you’re looking for you keep cash that is also something very important sooner or later you will find something and when it comes to keeping cash or holding something this is very important and very

Specific to clarman but also to warren buffett even if warren buffett doesn’t like to say it you know exactly what you bought and if that changes don’t hold if the reason for holding is no longer valid so clarman is definitely against buy and hold for no reason because as he says huge sums have been lost caused by investors who have held on to securities after

The reason for owning them is no longer valid in investing it is never wrong to change your mind it is only wrong to change your mind and do nothing about it and we have also discussed this in this video i’ll put it here in the card buffett usually sells nine out of 10 stocks that he holds so only one of the ten he buys is the buy and hold forever everything else


Something changes when it comes so he doesn’t like the risk and then he sells just think wells fargo ibm verizon etc etc 9 out of ten the next core think of value investing is relative versus absolute performance whenever it comes to investing if you talk about investing everyone will ask you did you beat the market did you beat the market for the record i cannot

Even compare what i did in the last 20 20 years with the market if i invested in the market i would still be a poor kid in some east european country but that is exactly the point of value investing if you focus on yourself you destroy the market you forget about the market you don’t care about the market but you have to forget about the market to be there and

Then again on the market comparisons if the market does 50 down and you do 40 are you happy well every other investor there says oh i did beat the market who cares but he’s still 40 down and when it comes to value investing value investing is about reaching your financial goals not caring about what others do because buying undervalued securities and selling when

Fully valued will lead to a good absolute return over time that we already discussed will allow compounding over the long term and therefore you cannot compare yourself to the market because the market will do better than you for a decade and then do worse than you for a decade over the long term you’ll do better because value investors prefer out of favor holdings

That may take longer to come to fruition but also carry less risk of loss and this is my favorite example of value investing versus something else this is the nasdaq composite of course 1990s there was bubble everyone was rushing into the nasdaq especially in the 2000s just before the peak and everyone was leaving warren buffett out when the nasdaq peaked

Berkshire was actually down 31 warren buffett was considered old and i don’t have to tell you that in the future berkshires earnings have done much better than the nasdaq we now again have a nasdaq bubble and i’m very curious how it will end the key point here is that this performance has been done with much lower risk than anything else and that is value investing

No matter what you just keep compounding and then again something that goes against peter lynch forever always fully invested because you must beat the market if you don’t have any ideas then you just invest in the market so you will perform equally that’s what investment managers do but absolute investors hold cash where no bargains are available as berkshire used to

Keep 160 billion in cash 150 now significantly less because the cash was losing money so that is very important to think about comparing constantly comparing okay the risk of investments and the value and the risk of the cash which leads us to the next part of the value investing puzzle which is risk and return and when it comes to investing it is much easier to focus

On where will tesla stock go how much money i can make because that is exciting that is what makes it much easier to part with your money and invest it because you’ll end up rich very very quickly that simply works with us humans and there is nothing we will be able to ever change about that only if we focus on value investing we’ve just drilled it into ourselves

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We might focus on the other side of things which is okay what can go wrong when i invest my money when i invest my future when i invest my financial stability everything do you want to get rich fast or you want safety of principle and that’s the core thing to understand when it comes to investing 97 of people will always go for the reward only three percent of us

That are watching this chapter 7 summary will focus on what can go wrong this is the standard measure of risk standard deviation and in academia they say that low risk gives low return high risk high return and risk is defined in financial terms as the chance that an outcome or investment actual gains will differ from an unexpected outcome or return quantifiably

Risk is usually assessed by considering the historical behaviors and outcomes in finance standard deviation is a common metric associated with risk which in value investing is complete bollocks let me explain this of course works only in an efficient market and value investors we firmly believe that it is possible to find low risk high reward investments and that

Is then the essence of not losing money and reaching a good absolute return and that might happen because information is not widely available in that situation so for example when somebody is selling or it’s not looking into the accounting looking at the real value of the assets which is then again when an investment is particular really complicated to analyze who

Can make days of days of research and analysis only few and then when investors buy and sell four reasons unrelated to value like we have seen at t dividend holders dumped for example warner bros or other spin-offs so this is what the market thinks but value investors actually believe that this is not low risk low return this is high risk low return for example

Bonds that we discussed in yesterday’s videos about pensions investing in a long-term bond at the one percent return is total risk for no return and that is exactly what risk is if you take risk sooner or later it erodes your return by causing losses and therefore we must focus on not taking risk for a good return that’s the only way to compound long term because

By itself risk does not create incremental return only price can accomplish that of course the risk of an investment is described by both the probability and the potential amount of loss the risk of an investment the probability of an adverse outcome is partly inherent in its very nature it is totally clear that investing in nikola cars here is much riskier than

Investing in the utility with stable projected cash flows etc so risk yes depends on both the nature of investment and then of course on the market price so you have to understand the nature of the investment and then compare that nature with the market price while security analysts attempt to determine with precision the risk and return of investments only events

Accomplished that so risk cannot be described by a number risk cannot be projected in the future only now looking back you can understand better if something happens then it is risky if it works it is not risky if i tell people that tesla has been risky since ever nobody believes me because they look at look at what they did look at the market share look at this

Look at that and then you say okay tesla is not risk if something fails if tesla would have failed then it would have been considered risky there are only a few things investors can do to counteract risk diversify adequately hedge when appropriate and invest with a margin of safety it is precisely because we do not and cannot know all the risks of an investment

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That we strive to invest at a discount the bargain element helps to provide the cushion when things go wrong so the core of value investing margin of safety even when things go wrong you want your protection of value of principle of wealth of whatever you are investing in therefore if you buy at a discount even if things go wrong and that value changes as we have

Discussed you are okay which is completely opposite with academics the beta that was very very cool still unfortunately used where it compares the securities portfolio with its historical price fluctuations comparing those with the market as a whole high beta stocks are defined as those that tend to rise by a higher percentage than the average stock in a rising

Market and decline more than the average stock in a falling market due to their greater volatility high beta stocks are deemed to be riskier than low beta stocks this is a great example this is free report mcmoran we discussed copper miners recently versus the s p 500 index and you can see that when the market goes up f6 goes up more when the market goes down

Fcx goes down more which then gives it a higher beta and therefore everyone says higher risk compared to the market however they only look at best price fundamentals and not add fundamentals at all which ignores the price and despite the beta i would say that at some price levels freeport make more and given the copper given the nature of the business is less

Riskier than the market for a higher return that’s value investing and the reality is that best security prices do not reliably predict future investment performance and therefore it’s a poor measure of risk and you can read a lot of academic papers on that how it is completely dismantled but it’s good to sell 250 000 education mbas around the world the next step

Is discussing the relevance of temporary price fluctuations risk is of course the probability of loss long term but that does not mean that your investment cannot go up and down we have to be able to distinguish between short-term price fluctuations and changes in business fundamentals and that is something that is only obvious about the fact but if you are buying

Sound value at a discount do short-term price fluctuations matter in the long run they do not matter much value will ultimately be reflected in the price of a security indeed ironically the long-term investment implication of price fluctuations is in the opposite direction from the near-market impact for example short-term price declines actually enhance the return

Of value investors so if prices go down and if there is value your returns will be higher because mr market can create very attractive opportunities to buy and sell great conclusion here the primary goal of value investors is to avoid losing money free elements of a value investment strategy make achievement of that goal possible a bottom-up approach searching for

Low risk bargains one at a time through fundamental analysis is the surest way i know to avoid losing money an absolute performance orientation is consistent with loss avoidance a relative performance orientation is not finally paying careful attention to risk the probability and the amount of loss due to permanent value impairments will help investors avoid losing

Money so long as the generating portfolio cash inflow is not inconsistent with earning acceptable returns investors can reduce the opportunity cost resulting from interim price declines and even as they achieve their long-term investment goals press the like button if you enjoyed subscribe if you haven’t i’ll see you next week with chapter 8 the art of business

Valuation from a value investment perspective

Transcribed from video
At The Root Of A Value Investment Philosophy – Chapter 7 By Value Investing with Sven Carlin Ph.D.