Principles of Value Investing
Toto, I have a feeling we’re not in Kansas anymore.
Yes boys and girls, put away your Excel spreadsheets and gather round the fire.
As Steve Jobs liked to say, “I’m going to tell you three things. No big deal. Just three things.”
That’s it folks.
3. Rain Falls Down
( Bonus: They apply universally and are equally and importantly relevant to entrepreneurship as well.)
Before you swoon in admiration of my unparalleled genius, I want to be clear that these ideas and even the phraseology are not mine.
This is what I learned from my master, my Yoda. (Thanks Tom, for changing my life!)
Yes folks, this changed my life. If you pay attention, it might do it for you.
And then again for those of you too lazy to listen, it might not. YMMV.
Definitions first and details later. Ok?
1. P/V : Price/Value
The fundamental metric of all investing. The ratio of the price you pay for the value you get. This needs to be less than one at all costs and the lower it is, the larger your margin of safety (remember margin of safety?: https://unrepentantlyrecalcitrant.wordpress.com/2013/10/10/all-investing-is-value-investing-the-rest-is-speculation/).
All of Wall Street that makes money off of you, conflates price and value. It is the fundamental thesis of those that believe the markets are efficient.
(If you believe that, what in gods name are you doing on my blog? Go visit that fool Cramer on CNBC or something!)
Price is what you pay, value is what you get.
The lower the price and the higher the value, the better the deal.
Buffet talks about buying a dollar for fifty cents.
That’s a P/V of 0.5
I will discuss the estimation of value in some detail in a later post.
2. EVA : Economic Value Added
Also known as Abnormal Earnings ( Economists always think that profit is an abnormal situation!), EVA is defined as:
Return on Invested Capital – Cost of Capital = EVA
As an example, if your capital costs you 9% ( say a bank loan for your business) and you are able to generate 9.9% return ( savvy investing or your business profits), you have an EVA of 10%
Needless to say, it should be a positive number!
Before you laugh at that, I will in the future show you why most businesses (the majority) are not getting a positive number and as a result have a zero EVA (bad!) or even a negative EVA ( yes, they are destroying capital!).
If you are an aspiring entrepreneur, you must (MUST) have plans for a positive EVA! If not, don’t even bother. More on this later.
3. Rain Falls Down:
A little more fuzzy than the others, this statement underlines that certain things are an inevitability.
You must prepare for them and account for them in your estimation of value and decision to invest ( or grow your business).
Your resistance to rain clouds and gravity is useless. Rain will fall down.
Simple so far, no?
Remember, Value investing is simple but it’s not easy! Oh No!
I will take each of these points and expand on them in future posts.
I will review the only economic principle(s) that matter ( YES, most of economics is a massive waste of your time!)
The only thing I can’t help you with is mental toughness.
(You need to review Kipling’s poem again and internalize it!: https://unrepentantlyrecalcitrant.wordpress.com/2013/10/06/rudyard-kipling-was-a-value-investor/)
Oh, one last thing. You know that money you saved up to buy the latest Excel program?
Go get a great dinner instead.
You ain’t gonna need Excel anymore.