Do you know how to differentiate between value investing and growth investing, or for that matter value investing with any other form of investing? I will leave this for readers of TIPBlog to ponder over it. However, I would like to say one thing; I do not know how to differentiate. I invest with an objective to grow my capital. It does not matter where it comes from. Hold on, don’t pass a judgment yet.
Let us take an example. Late last year, Buffett bought a whole rail company, Burlington Northern Santa Fe. On per share basis, the price paid by Buffett was (1) 31.5% premium to prevailing market price at the time of announcement; and (2) Approximately, 15 PE ratio at the time of announcement.
At first glance, these two matrices will tell you, “that was not cheap!”. That’s because in today’s world of instant gratification, we have come to believe PE ratio and/or current premiums are only ratios that determines value. We have dropped the meaning of value to few parameters. Small time investors like you and me would jump to take 31% premium and declare victory. But 20 years down the road, Buffett is likely to be basking in glory.
The point I am trying to make is ability to judge value is much more than crunching few numbers in excel sheet. What we consider premium today even at 15PE or 20PE, it may be actually undervalued when look ahead 20 years from now. Like single digit PE ratio does not necessarily mean value (could be value trap), similarly, a high PE ratio could still mean value. Key element is ability to project growth, or anticipate growth, or understand moat, or competitive advantage. And this comes from understanding of the domain.
The much beaten down proverb, “know what you are investing in”. Easy to say but very difficult to practice.
It is in this context, it is not necessary for value to existing only in stocks and shares of a company. Value can be found in any forms of investment, any type of company, or any type of investment vehicle.
In the beginning I said, “I invest with an objective to grow my capital. It does not matter where it comes from”. So it does not matter whether it is a growth, value, small, mid, large, bonds, real estate, commodity, futures, options, derivatives, etc… Fundamentally, I am open to at least let pass all of them through my objective screen.
The only reason, I stick to stocks and shares, is because I think I can make some very objective decisions. I have some control over what I buy, at what price, when I sell, at what sell price, at what point, etc. Meaning, I have some understanding of the full chain of activities right from thinking of buying it … to… deciding to sell. Stock markets or online accessibility are just means to reach them. Even in case of stocks, so far, I have remained stuck to my long term buy and hold objectives. I have invested in shares of companies that had certain characteristics to meet those objectives.
I have mentioned I am looking to expand my horizon and include some other companies where there are value opportunities. The question is where and what? Shooting in dark is less likely to hit the target, and forget that you could even hit the bulls eye. So I need to know the target area in the available landscape.
(1) Companies that have moat, significant market competitiveness, market share, capital intensive, growth potential etc. These companies are worth holding for long time. Typically, my growth expectations are conservative. But they are likely to be sustainable and consistent. Examples are ONGC, Hero Honda, L&T, NTPC, Pidilite, Asian Paints, Infosys, Graphite, Aegis, etc. The opportunities to buy such companies come during market down turns, unless there is something explicitly wrong (event driven or otherwise). One can even buy at premium based on individual’s risk profile. The key here is to watch them and have free capital available.
- So far I have been investing in companies in this category. Dividend and capital appreciation were the objectives. And I will continue to look for such companies. I would most likely sell only in case of insanely high valuations.
(2) Companies that have market share, current moat, low capital needs, operational efficiency, etc, but potential future growth is not visible. Growth could be cyclic, high, low, or needs large capital, etc., Examples are Hawkins, ABCIL, Camphor, etc., One can continue to hold them, or sell them at extremely high valuations, add to them, reduce, etc. These companies can be bought cheaper to intrinsic value, or current premium. If you believe there is higher growth, then you may pay current premium. If you don’t believe there is growth, then pay only discount.
- This is the area that I am going to expand. This is what I mean by value opportunities. Here, my objective is capital appreciation based on growth in value. Dividends are not necessary and hence, I need to tweak my process little bit to meet these objectives.
(3) Companies that are somehow running. Examples are Ador, Cheviot, GE Shipping, etc. At least for me, I do not consider them as value preposition. These may be opportunistic if one can buy them in depressed markets. They may also include cigar butts. It is advisable to sell them after market recovers to certain extent. Again this is my understanding of such companies in the context of value.
- I am not chasing these types of companies or these type of opportunities. Because, it is hard for me to really figure out what I should I pay to buy them and when I should time to sell them.
(4) Companies that are in event driven situations like mergers, acquisitions, buyouts, temporary chaos, scandal, etc., Temporary chaos is like BP in US or any other drillers in Gulf of Mexico, or Airlines in India. Example for scandals are Satyam immediately after the announcement.
- I am not chasing them. I am not good at grasping these events. I am not good at anticipating potential returns. I am not good at timing them.
(5) All other financial vehicles like options, futures, derivatives, etc. Here also, I do believe there is value to be found. Only if one knows how/what/when! The optional warrants that Buffett got from GE and Goldman are also kind of financial derivatives. They are simple to understand. Buffett knows its value and understands potential returns.
- I don’t understand them, so I am not chasing them.
This has been my understanding of value investing landscape. Value is much more than PE ratio or crunching few numbers or cheaper price today. You can find value in almost any financial instruments, any type of company, any situation, or any events. Only if you understand the entire chain from buying to selling. In my opportunistic plays, I am going to look for companies as described in item (2) above.
What does value mean to you? What does value opportunity mean to you? Did you still think value means buying cheap during market depression only?
long term investing, type of value opportunities, value opportunities, value trap