The Manual of Ideas (by John Mihaljevic)
How to do value investing. Several possible ways...
- Think like a capital allocator, not like small fish. Would you like to own
the whole business? Then you probably also want to own some shares, otherwise
it's unlikely.
- Grapham approach (Deep Value): buy severely underpriced stocks (based on
liquidation value). They are probably crap, but the price is so good that you
still make money on average (although you might need to liquidate the
company, so make sure you can do it if you need it).
- Sum of parts approach: companies that own productive assets worth more than
the company.
- Magical Formula: great businesses at a reasonable price. Adjust the classical
magical formula by using future consensus estimates instead of (or together
with) the past.
- Beware cyclical businesses or otherwise transient high returns. When the
returns go down the price will follow with vengeance.
- High ROI is only useful if the resulting cash can be profitably invested.
- Look for great management teams, especially if they are not overhyped and
overvalued. A good start is eliminating the really bad ones and looking for
cheap companies in the rest.
- One possible test for bad management is if management compensation is high
and not tied to performance of the business.
- Do managers communicate honestly in shareholder letters? Do they answer
tough questions in the Q/A of earnings calls?
- Is the board independent and aligned with the shareholders (e.g. via
ownership)?
- Look for high ROCE, high CE, shareholder-friendly capital allocation.
- Great capital allocators are more valuable and harder to find than great
business leaders.
- Following great investors. See book for the list of people to follow. Things
to pay attention to:
- Position size, change from last,
- Percentage of company owned (can show those 5%, 10%, 20% boundaries),
- Stock price change since filing date.
- Small caps can return more but the risk is also higher.
- Accounting is often simpler with small caps so it's easier to understand
the company.
- Mind the liquidity.
- Good pattern: poorly performing business + small fast growing business
inside of one company -- quantitatively the whole company will look bad but
second business will win over time.
- Special situations often make the market more wrong for one reason or another
- Examples:
- Deletion from index - index funds will sell.
- Dividend cancelation - dividend funds will sell.
- Spin-off - owners of parent might sell the spin-off without regard for
merit.
- Post-hype sleeper - hype is over, traders exit, but the company is
actually doing well.
- Watch out for special situations when screening.
- Sometimes it's possible to predict these if you're paying attention.