Deep Value Investing Definition: Value Investing
Deep Value Investing Definition
What is deep value investing? What is the definition of deep value investing?
Value investing is about buying a stock for substantially less than what it is actually worth (i.e. its intrinsic value). Deep value investing seeks to purchase stocks at an even greater discount to their intrinsic value.
Value investors assert that “Mr. Market” often inefficiently prices stocks in the short-term for various reasons (e.g. forced stock sales, bad publicity, lack of analyst coverage, etc.). Once disciplined value investors have performed the required fundamental analysis of a business they will arrive at an estimate of the “intrinsic value” of the stock. This intrinsic value is compared to the current selling price and if there is enough of a discount, value investors will strongly considering purchasing the stock.
Some value investors will also try to determine potential catalysts (e.g. spin-off or sale of hidden assets) that could potentially cause other investors to consider a purchase or that could otherwise unlock value.
Value investors contend that purchasing a stock at a sufficient discount to intrinsic value or allowing for a “margin of safety” also reduces risk. The value investor believes that further price deterioration is less likely since negative opinions are already likely factored into the stock price. Further, existing shareholders who still haven’t sold their positions likely realize the value in the stock and may be unlikely to sell at such a discount.
The quickest way to learn something is to ask those who are masters. To explain the deep value investing definition, we turn to famous deep value investors such as Benjamin Graham and Warren Buffet. Other value investors such as Irwin Michael, Seth Klarman or Joel Greenblatt also have their own deep value definitions or deep value investing strategies.
Benjamin Graham and Warren Buffet believe that buying a stock at a sufficient discount to intrinsic value allows for a margin of safety. Buffet has modified his strategy somewhat from Graham by also considering franchise value and the earnings power, stability, and growth prospects of company.
Irwin Michael sums up his deep value investing philosophy by “buying toonies for loonies” (note: in Canada, a toonie is a 2 dollar coin and a loonie is a 1 dollar coin). Michael follows his “Ten Commandments of Value Investing.”
Joel Greenblatt believes that buying great companies (as defined by a high ROE or return on equity) at cheap prices (as defined by a low EBIT or earnings before interest and taxes) is the way to consistently outperform the market. In the words of Warren Buffet, “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Indeed, Greenblatt’s value investing strategy aims to do both – buy a wonderful company at a wonderful price.
Seth Klarman writes “Value investing is the discipline of buying securities at a significant discount from their current underlying values and holding them until more of their value is realized. The element of a bargain is the key to the process. In the language of value investors, this is referred to as buying a dollar for fifty cents. Value investing combines the conservative analysis of underlying value with the requisite discipline and patience to buy only when a sufficient discount from that value is available.” (Klarman, Seth A. “Margin of Safety,” p. 64.)
Klarman also describes the basic tenants of value investing. “There are three central elements to a value-investment philosophy. First, value investing is a bottom-up strategy entailing the identification of specific undervalue investment opportunities. Second, value investing is absolute-performance, not relative-performance oriented. Finally, value investing is a risk-averse approach; attention is paid as much to what can go wrong (risk) as to what can go right (return).” (Klarman, Seth A. “Margin of Safety,” p. 76.)
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CoattailCorner.com has a newsletter that follows selected stock purchases of successful investors and is primarily focused on deep value and value investing stock picks.
Copyright © 2010 by DeepValueInvestor.com. All rights are reserved.
Value Investing: Book Review
Value Investing: From Graham to Buffet and Beyond
Review
Value Investing
VALUE INVESTING is written by Columbia University professor Bruce C. N. Greenwald along with co-authors Judd Kahn (PhD University of California), Paul D. Sonkin (Hummingbird Value Fund), and Michael Van Biema (Phd Columbia, Finance Faculty Columbia).
Similar to other value investing authors, Greenwald et al. proposes that the market is not perfectly efficient and that individual investors can beat the market indices by investing in undervalued stocks. Greenwald et al. also proposes that risk does not equal volatility (as is common in many finance texts) but rather the permament loss of capital. These are both very important philosophies and the underpinnings of many value investors.
Greenwald et al. first propose that the value of a company is equal to all the discounted cash flows that the owners (shareholders) will receive. The problem with this approach, Greenwalds contends, is that significant variations in this simple calculation are the result given even small changes in key underlying assumptions.
Instead, Greenwald et al. propose a three element approach to valuation that includes valuing assets, earnings power, and profitable growth. Asset valuation is a balance sheet approach to valuation where the figures are generally known and quantifiable. Earnings power and profitable growth are income statement and forecasting approaches that are less reliable but still very much a valuable approach.
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While the authors begin with the balance sheet when attempting to understand the value of a company, they also try to build the replacement cost of the asset. This includes not only physical plant and equipment but also what it costs to build the required customer relationships, distribution networks as well as specialized products or services. Accordingly, the authors also give value to research and development costs as well as sales and marketing.
The authors contend that identifying the long-term earnings power of a company is essentially a qualitative exercise whereby one has to be able to identify whether or not a company has differentiated products or brands and whether or not it is able to achieve sustainable competitive advantage.
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Potential areas to identify opportunity are those companies that have hidden assets that management may or may not know about. Companies with complicated businesses or financial statements are also opportunities to identify possible value situations. This is an interesting comment given that Warren Buffet (who the authors themselves profile) has often contended that if a company is too complicated, he will pass.
The last half of the book highlights practical implementations of value investing by investment managers including:
- Warren Buffet
- Mario Gabelli
- Glenn Greenberg
- Robert H. Heilbrunn
- Seth Klarman
- Michael Price
- Walter and Edwin Schloss
- Paul D. Sonkin
While Greenwald et al. contends that it is possible for the individual investor to beat the market indices that comes with a very serious caution. “We think that direct and active investing is a dangerous game, not a trick one can do casually at home.” (p. 158)
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Book Information
Title: Value Investing: From Graham to Buffet and Beyond
Author: Bruce C.N. Greenwald, Judd Kahn, Paul D. Sonkin, Michael van Biema
Publisher: John Wiley & Sons, Inc., Hoboken, New Jersey
Publication date: 2001
Number of pages: 291
Review Information
Reveiwer: DeepValueInvestor.com
Date of First Review: July 2011
Updated:
Stars (9/10)
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
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DeepValueInvestor.com regularly reviews books on deep value investing and value investing. Check out our dedicated page on value investing book reviews.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
You Can Be a STOCK MARKET GENIUS: Book Review
You Can Be a STOCK MARKET GENIUS: Uncover the Secret Hiding Places of Stock Market Profits
Review
You Can Be a STOCK MARKET GENIUS is the first book written by Joel Greenblatt. This book is probably the most advanced of the three books he has now written (his second book is The Little Book that Beats the Market; and his third book is THE BIG SECRET for the Small Investor).
Greenblatt starts by explaining “why” an individual investor can beat the market averages even though the vast majority of both professional and individual investors actually underperform the market. The basic premise is that the stock market is not efficient – particularly in the short term. This means some securities will, from time to time, trade at compelling prices that do not reflect the true underlying value. Greenblatt also explains that there are areas of the stock market which larger investors ignore for a variety of reasons – it is these areas where an individual investor has an opportunity to uncover bargains.
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Greenblatt also takes an interesting view on diversification. Greenblatt proposes that purchasing 6 to 8 stocks in different industries is usually sufficient to substantially reduce the nonmarket risk of owning just one stock. Overall stock market risk, however, is not eliminated and the investor is still subject to this risk. (It is equally interesting to note, however, that one of Greenblatt’s latest investing undertakings is value-weighted indexing which actually involves the purchase of several hundred stocks).
Moving on to “how” to achieve success in the stock market, Greenblatt explains that dedication, hard work and patience are all prerequisites. Greenblatt also stresses the importance of, first and foremost, selecting investments that provide the investor with downside protection – rather than focusing on how much of a return is possible.
Some of the secret places to make money in the stock market are listed below but you’ll have to read the book to understand how and why. Here’s a listing of the secret investing places that Greenblatt discusses:
- spinoffs;
- following insiders;
- risk arbitrage and merger securities;
- bankruptcies;
- restructurings;
- recaps;
- stub stocks;
- leaps;
- warrants; and
- options.
Greenblatt also lists specific resources you can use to help find opportunities. This includes raw data sources such as regulatory filings but also selected secondary sources from newsletters and other publishers. (Of course, you can also sign-up for our free Deep Value Investing newsletter here).
For those willing to engage in hard work, dedicate themselves and their time, and demonstrate the required patience, You Can Be a STOCK MARKET GENIUS is a must-read.
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Book Information
Title: You Can Be a STOCK MARKET GENIUS
Author: Joel Greenblatt
Publisher: Simon & Schuster, New York
Publication date: 1997
Number of pages: 285
Review Information
Reveiwer: DeepValueInvestor.com
Date of First Review: April 2011
Updated:
Stars (9/10)
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
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DeepValueInvestor.com regularly reviews books on deep value investing and value investing. Check out our dedicated page on value investing book reviews.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
Net Asset Value – NAV: Value Investing
What is NAV? From an investing perspective, NAV is Net Asset Value.
How to calculate Net Asset Value (NAV). Calculating Net Asset Value is theoretically as simple as: NAV = Total Assets – Total Liabilities. There are some differences in the calculation of NAV depending on what type of investment is being examined but the overall principle is the same.
Value Investing Strategy: Buying at a Discount to Net Asset Value (NAV). A value investing strategy that is common among value investors is to buy stocks that are trading significantly below their NAV or Net Asset Value. This provides a margin of safety. Some value investors will also deduct the value of intangible assets from their calculation of NAV. One of the first value investing strategies published was to buy stocks trading at a discount to their Net Net Working Capital.
Mutual funds – Net Asset Value per Unit (NAVPU). NAVPU is the dollar value per mutual fund unit after subtracting the funds’ liabilities from the assets and then dividing that figure by the number of units issued and outstanding. Typically, liabilities of most long-only mutual funds are relatively low compared to the amount of assets. Generally speaking, mutual funds are quoted at NAVPU and can be sold or purchased at a price equal to NAVPU less transaction costs. Mutual funds are often referred to as open-ended funds because they can be bought and sold at NAVPU at most anytime.
Closed-end Funds – Net Asset Value per Unit (NAVPU). The NAVPU for closed-end funds is calculated in the same manner as mutual funds or open-end funds – i.e. total assets less total liabilities divided by the number of units issued and outstanding. The difference with closed-end funds is that they are typically not redeemable by the investment manager. Investors in closed-end funds looking to liquidate or cash-in their position must generally do so by selling their units to another investor which is often done so at a discount to the NAVPU. Closed-end funds often trade on exchanges like any other stock. This makes closed-end funds susceptible to the day-to-day supply and demand of the units which also contributes to whether the units are trading at either a discount or premium. Closed-end funds often trade at a premium in a short period subsequent to an IPO but thereafter trade at a discount to NAVPU.
Common Stock: Net Asset Value Per Share (NAVPS). Basic NAVPS is calculated as total assets less total liabilities. This is also sometimes referred to as Book Value per Share or Equity per Share. Variations of calculating NAVPS can also include estimating a current market value of assets. Since accounting rules typically require companies to value assets at historical cost, there can be wide and significant variations between the book value of an asset and the current market value.
Common Stock: NAVPS for Commodity Based and Precious Metal Stocks. NAV per share is typically calculated and reported by engineers for oil and gas stocks as well as mining stocks. These calculations are generally required to be disclosed in regulated annual reporting forms. Engineers calculate NAV by discounting future net cash flow streams (i.e. discounting the revenues less operating costs and some capital costs). Stocks rarely trade at a price equal to NAV and could trade at either a discount or premium reflecting numerous other factors such as short-term supply and demand of a stock, investor outlook, whether or not a current sector is favoured by the market or not, differences in the discount rate used by Engineers versus investors, etc.
Net Asset Value (NAV) is an important component of value investing strategy. How NAV is calculated depends on the type of investment being evaluated as well as the assumptions that an investor makes in regards to each variable that is used to calculate Net Asset Value (NAV). NAV is another tool that value investors may use to evaluate a stock or any other investment.
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Related terms: Net Asset Value Definition, NAV Definition, How to Calculate Net Asset Value, How to Calculate NAV, Net Asset Value per Share NAVPS, Net Asset Value per Unit NAVPU, Net Asset Value Definition, NAV Definition
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
The Little Book that Beats the Market: Book Review
THE LITTLE BOOK THAT BEATS THE MARKET
Book Review
“Make everything as simple as possible, but not simpler,” is what Einstein said. Joel Greenblatt has done a fantastic job of writing a book that will appeal to both novice and professional investors alike. Greenblatt has a rather unique resume of being an extremely successful practitioner, a professor, and now an author.
“The Little Book That Beats The Market” is a very quick read and Greenblatt keeps the concepts interesting and uses very plain, simple and easy to understand language. Each chapter also highlights key points to remember which further assists in learning the concepts.
The book focuses on two key concepts that are not dissimilar to Warren Buffet’s practice of buying “a wonderful company at a fair price.” Although he doesn’t mention Buffet, these two key concepts are the components of Greenblatt’s “Magic Formula.” Greenblatt defines great companies as having a high return on capital (i.e. the company makes a very good profit relative to the amount of capital needed to run the business). Once great companies are identified, the challenge is to buy them at great prices. This is where Greenblatt explains the concept of earnings yield (i.e. the amount of earnings relative to the current stock price).
Greenblatt does an excellent job of explaining the technical aspects of the Magic Formula. More importantly he explains why the Magic Formula works.
“The Little Book That Beats The Market” is highly recommended and will prove to be a timeless book for anyone interesting in successful investing.
Key concepts discussed:
- Return on Capital
- Earnings Yield
Stars (9/10)
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
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DeepValueInvestor.com regularly reviews books on deep value investing and value investing. Check out our dedicated page on value investing book reviews.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
THE BIG SECRET for the Small Investor: Book Review
THE BIG SECRET for the Small Investor: A New Route to Long-Term Investment Success
Book Review
There are actually a number of big secrets and for more people than just the small investor. Joel Greenblatt answers the question “how to invest in the stock market.”
Greenblatt provides another easy read crammed with valuable information. With each subsequent book he writes, his message is further and further simplified. His writing style is extremely entertaining, thought provoking, and understandable.
The thought process that Greenblatt is trying to instill into readers is very similar to Margin of Safety written by Seth Klarman. Greenblatt’s approach is certainly very different but at a high level he explains: first, why many individual and professional investors don’t and/or can’t beat the market; second, a philosophy that explains and demonstrates why an individual can beat the market and most professionals; and third, how to easily implement a successful long-term investing strategy.
“THE BIG SECRET for the Small Investor” is a must-read for active and passive investors, individual and institutional investors, pension plans, and yes, even mutual fund companies.
There is a big secret to investing at the beginning of the book and another big secret to investing at the end of the book. Most importantly, however, the entire book explains why others fail and why you can succeed. As Greenblatt explains early on “understanding…is…crucial” (p. 18).
The Big Secret will only make sense if you read the entire book in order to develop a solid understanding and that is really the big secret. Join our newsletter — as we add tools related to THE BIG SECRET, you will be notified. Our newsletter also follows stock picks of successful value investors.
Key concepts discussed:
- Why most investors don’t beat the market indices
- Why you can beat the market indices
- How you can beat the market indices
- Margin of Safety
- Value Weighted Index
- Numerous Big Secrets to Investing
Book Information
Title: THE BIG SECRET for the Small Investor
Author: Joel Greenblatt
Publisher: Crown Publishing Group, a division of Random House Inc., New York
Publication date: 2011
Number of pages: 156
Review Information
Reveiwer: DeepValueInvestor.com
Date of First Review: April 2011
Updated:
Stars (9/10)
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
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DeepValueInvestor.com regularly reviews books on deep value investing and value investing. Check out our dedicated page on value investing book reviews.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
From the publisher:
When it comes to investing in the stock market, investors have plenty of options:
1. They can do it themselves. Trillions of dollars are invested this way.
(Of course, the only problem here is that most people have no idea how to analyze and choose individual stocks. Well, not really the only problem. Most investors have no idea how to construct a stock portfolio, most have no idea when to buy and sell, and most have no idea how much to invest in the first place.)
2. They can give it to professionals to invest. Trillions of dollars are invested this way.
(Unfortunately most professionals actually underperform the market averages over time. In fact,it may be even harder to pick good professional managers than it is to pick good individual stocks.)
3. They can invest in traditional index funds. Trillions of dollars are also invested this way.(The problem is that investing this way is seriously flawed–and almost a guarantee of subpar investment returns over time.)
4. They can read The Big Secret for the Small Investor and do something else. Not much is invested this way. Yet…
Let top hedge fund manager, Columbia business school professor, former Fortune 500 chairman and New York Times bestselling author, Joel Greenblatt, take you on a journey that will reveal the Big Secret for both individual and professional investors. Based on path-breaking new research, find out how anyone can beat the market, the index funds and the experts by following a new approach that relies on the principles of value investing, common sense and quantitative discipline. Along the way, learn where “value” comes from, how markets work, and what really happens on Wall Street. By journey’s end, small investors (and even not-so-small investors) will have found their way to some excellent new investment choices.
About the Author
JOEL GREENBLATT is the founder of Gotham Capital, an investment partnership that achieved 40 percent annualized returns for the twenty years after its founding in 1985. He is a professor on the adjunct faculty of Columbia Business School, a managing principal and co-CIO of Gotham Asset Management, the former chairman of the board of a Fortune 500 company, and the author of You Can Be a Stock Market Genius and The Little Book That Beats the Market. Greenblatt holds a BS and MBA from the Wharton School at the University of Pennsylvania.
Margin of Safety: Value Investing
Margin of Safety – Value Investing Criteria
Margin of safety is the basis of value investing strategy. The father of value investing, Benjamin Graham proposed in The Intelligent Investor that “to distill the secret of sound investment into three words, we venture the motto, “MARGIN OF SAFETY.[1]” Seth A. Klarman, a disciple Graham and famous value investor himself literally wrote the Margin of Safety book.
What is a margin of safety?
In our “Deep Value Investing Definition” article we wrote that value investing is about buying a stock at a sufficient discount to intrinsic value. Buying a stock at a significant discount to its intrinsic value allows the investor to have a “margin of safety.”
To help construct a margin of safety definition, Graham contends, “We have here, by definition, a favourable difference between price on the one hand and indicated or appraised value on the other. That difference is the margin of safety.[2]” Graham explains that a margin of safety can only certain if reasonable and rational analysis can demonstrate that the price paid for the stock is substantially less the value of the underlying assets.
Warren Buffet describes this succinctly, “Price is what you pay. Value is what you get.” The value investor looks to pay a price much less than the value received – and that difference is the margin of safety. In other words, value investing is about buying a dollar for fifty cents – therein lies the margin of safety.
Very simply, Joel Greenblatt explains in The Big Secret for the Small Investor that the concept of margin of safety is about “leaving a big space between the value of what you are buying and the price you pay.[3]”
Why is a margin of safety important?
In Margin of Safety, Seth Klarman explains “that value investors seek a margin of safety, allowing room for imprecision, bad luck, or analytical error in order to avoid sizable losses over time. A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes.[4]” Buying a stock with a significant margin of safety reduces both the likelihood and severity of potential losses.
Value investors don’t just like to avoid losses though – they still like to make money, of course. Graham wrote, “A strong-minded approach to investment, firmly based on the margin-of-safety principle, can yield handsome rewards.[5]”
How do we get a margin of safety?
“The margin of safety is always dependent on the price paid,” writes Graham. “It will be large at one price, small at some higher price, nonexistent at some still higher price.[6]”
Klarman says that investors achieve a margin of safety, “By always buying at significant discount to underlying business value and giving preference to tangible assets over intangibles.[7]” Much of a potential return is earned as the price of the stock begins to reflect the underlying value of the assets.
In order for the gap to narrow, the investor must try to first understand why the discount exists and second, whether there are any catalysts that will help the stock rise to reflect the true underlying value.
Conclusion
Margin of safety is the central theory of value investing. First and foremost, a margin of safety first helps ensure the goal of preservation of capital and loss mitigation. It is about buying securities at substantial discounts to their actual value and then maintaining these holdings until the mispricing is eliminated by the market (or unless other information becomes available that could change the original investment thesis), thereby earning the value investor satisfactory returns.
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About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
[1] Graham, p.512
[2] Graham, p. 517
[3] Greenblatt, p. 96
[4] Klarman, p.7
[5] Graham, p. 10
[6] Graham, p. 517
[7] Klarman, p. 68
Intrinsic Value: Value Investing
How to Value a Stock: Calculating Intrinsic Value
In our “Deep Value Investing Definition” article we wrote that value investing is about buying a stock at a sufficient discount to intrinsic value. This article will further discuss classic definition or the first widely published formula that was used to calculate intrinsic value. We also introduce other various valuation methods that some investors use to arrive at an estimate of a stock’s (company’s) intrinsic value.
The calculation of intrinsic value is as much art as science. Any investor can run a mathematical screen to identify stocks trading at various metrics that could indicate potential value. However, it must take keen business sense and deep curiosity to ask why a stock may be trading at the level it is, whether there actually is business value and how much, and what potential catalysts could emerge to unlock value.
To calculate intrinsic value, Benjamin Graham created a simple formula:
Intrinsic Value = E (2 * R + 8.5) * 4.4 / Y
where:
E = the company’s earnings per share
R = the company’s expected earnings growth rate
Y = the current yield on AAA corporate bonds
Graham advocated only buying stocks trading near or, preferably, significantly below its intrinsic value. (Source: Janet Lowe, Value Investing Made Easy)
Of course, the Graham’s intrinsic value formula assumes the company is a “going concern” (i.e. the company will continue to operate in a manner that allows it to earn revenue and contractually discharge its liabilities). This is quite different than valuing a stock on a “liquidation” basis which attributes little value to earnings (likely even a negative value for expected losses) and primarily considers the current market value of saleable assets after accounting for disposal costs. The details here are beyond the scope of this article but it is an important consideration worth mention.
The most successful value investor of all, Warren Buffet, was not always sold on the use of formulas. Buffet advocated buying great businesses at good prices. Buffet would first determine what type of business he wanted to buy and then waited to buy that business (stock) at a good price. Graham’s intrinsic value formula could be one tool to help assess whether the current trading price provides a sufficient margin of safety but Buffet always advocates that the first step is to identify great businesses.
In Value Investing, Greenwald et al. proposes that intrinsic value “is the discounted value of the cash that can be taken out of a business during its remaining life.” This is also commonly known at the Discounted Cash Flow (DCF) model. Of course, the calculation of DCF has many important underlying assumptions that can result in widely varying results. Consequently, it is not a model that all value investors rely upon nor is it a model that is supported in practice by Greenwald et al.
Further Discussion for Stock Valuation
Other methods of estimating or calculating the value of a stock include:
* Discounted Cash Flow
* Net Asset value (Book vs Market)
* Liquidation value
* Net Net Working Capital or Net Current Asset Value
* Other commonly quoted metrics: Price to Earnings, Price to Sales, Price to Book
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About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
Net Net Working Capital: Value Investing
What is Net Net Working Capital?
Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
“Net Net Working Capital” (NNWC) is one of the first stock valuation screening methods to be defined in the value investing world. Benjamin Graham also referred to this as Net-Current-Asset Value (NCAV).
The Net Net Working Capital formula may help identify undervalued stocks. Benjamin Graham actually used the term “Net Working Capital” but current value investors and Graham followers use the terms “net nets” or “Net Net Working Capital” interchangeably.
One value investing strategy of Graham was to purchase stocks that were trading at less than two-thirds of the Net-Current-Asset Value per Share (i.e. less than two-thirds of the Net Net Working Capital Value per Share). This type of value investing strategy could be thought of as a “liquidation value investing strategy”. In other words, Graham is proposing that the stock is so cheap that even under a situation where the business was wound down, that the investor would have a such a suitable margin of safety that a return could still be earned. Of course, Graham is not counting on a liquidation since there are costs associated with that action. Rather, Graham is satisfied that he is paying nothing for the fixed assets of the business nor is he paying anything for any potential earnings.
According to Graham, “The type of bargain issue that can be most readily identified is a common stock that sells for less than the company’s net working capital alone, after deducting all prior obligations.* This would mean that the buyer would pay nothing at all for the fixed assets—buildings, machinery, etc., or any good-will items that might exist. Very few companies turn out to have an ultimate value less than the working capital alone, although scattered instances may be found.” (Source: The Intelligent Investor by Benjamin Graham).
Of course, stocks that are trading below their NNWC may be trading at such low multiples for various reasons (e.g. pending bankruptcy, misstated financial statements, or a host of reasons why investors may be shunning a particular stock). Regardless, we present the Net Net Working Capital formula and provide further discussion.
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Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
Once the NNWC is determined, this amount divided by the number of shares outstanding will provide the NNWC per share. NNWC per share that is less than the current share price may be an indication of an undervalued stock or a deep value stock. Graham advocated buying a basket of stocks whose prices traded significantly below NNWC per share (or Net Current Asset Value per Share – NCAV per Share).
The NNWC formula considers that not all balance sheet amounts may reflect current reality. A 25% discount is applied to accounts receivable as these amounts may not actually be collectible. In addition, a 50% discount to inventory is applied given that it may be stale or obsolete. Of course, this is a first screen and potential investors should consider whether further discounts would be prudent.
The estimation or calculation of intrinsic value is as much art as science. Any investor can run a mathematical screen to identify stocks trading at various metrics that could indicate potential value. However, it must take keen business sense and deep curiosity to ask why a stock may be trading at the level it is, whether there actually is business value and how much, and what potential catalysts could emerge to unlock value. The Net Net Working Capital formula is one more value investing tool.
Net Net Working Capital Formula – Further Analysis and Discussion:
Net Net Working Capital is a subset of Graham’s Net Working Capital is a subset of Net Working Capital (also known as Working Capital).
1) Net Working Capital = Current Assets – Current Liabilities
2) Graham’s Net Working Capital = Current Assets – Total Liabilities
3) Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
Note that the results of each formula are presented in a decreasing order. That is to say Net Net Working Capital will provide the lowest and hence, most conservative, value. In other words, all else being equal, of the three formulas above, a stock trading below Net Net Working Capital provides the investor with the largest margin of safety.
In our “Deep Value Investing Definition” article we wrote that value investing is about buying a stock at a sufficient discount to intrinsic value. Graham’s “Net Working Capital” or the “Net Net Working Capital” formulas can be used as preliminary screens to identify potentially undervalued stocks or deep value stocks.
Related Terms: Net Net Working Capital Formula, Net Net Working Capital Calculation, Net Net Working Capital Definition, Net Net Working Capital Change, Net Asset Value (NAV), Net Asset Value per Share (NAVPS).
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About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
Think and Grow Rich: Book Review
THINK AND GROW RICH
Book Review
Although not a “value investing” book per se, we chose to review “Think and Grow Rich” for several reasons. First, value investing is a mindset – you have to be in a frame of mind that will allow you to grow and learn. Further, just like Napoleon Hill studied financially and otherwise succesful people to determine the quickest and surest route to success, DeepValueInvestor.com studies and follows successful value investors. Finally, this is an action book that you can use on your value investing quest.
Napoleon Hill’s book “Think and Grow Rich” shares and explains “the secret” and “the magic formula” to attaining wealth or, indeed, success of any kind. The secret was explained to Hill by Andrew Carnegie in the early 1900s. At the time, Hill was a boy and Carnegie asked him to spend the next 20 years preparing so that he could share the secret with the rest of the world. Hill kept his promise and anyone who reads the book and opens their mind will learn the secret that the most wealthy and powerful already know.
“Think and Grow Rich” is the book you need to think yourself to wealth or to think yourself to accomplish anything in your life. This is a book of thoughts and actions! Required reading!
Key concepts discussed:
- Think and Grow Rich (expanding further will give away the secret – read the book!)
Stars (10/10)
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
*** Learn more about value investing and follow value investing stock picks - sign-up for our free newsletter! ***
DeepValueInvestor.com regularly reviews books on deep value investing and value investing. Check out our dedicated page on value investing book reviews.
Copyright © 2010 by DeepValueInvestor.com. All rights are reserved.
Value Investing Made Easy: Book Review
VALUE INVESTING MADE EASY
Book Review
Janet Lowe has written several books about value investing and Warren Buffet. In “Value Investing Made Easy” Lowe condenses the theories of Benjamin Graham, David Dodd and Warren Buffet into an easy read. Furthermore, each chapter has a conclusion and highlights key points to remember which helps drive home the main ideas.The book is also sprinkled with various quotes from value investors who are disciples of Graham. The book moves from explaining concepts and importance of value investing and then moves into the basic mechanics of understanding financial statements. Lowe explains to the reader the basic but important calculations, including how to value stocks, that Graham and Dodd shared. Building a portfolio and risk management methods are also described.
“Value Investing Made Easy” is a good introductory book for the investor who is just starting out or a great book to remind the seasoned investor to stick to the time-tested basics of value investing.
Key concepts discussed:
- Margin of safety
- Intrinsic value
- Net current asset value
- Dividends
- Earnings growth
Stars (8/10)
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
*** Learn more about value investing and follow value investing stock picks - sign-up for our free newsletter! ***
DeepValueInvestor.com regularly reviews books on deep value investing and value investing. Check out our dedicated page on value investing book reviews.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
Margin of Safety: Book Review
MARGIN OF SAFETY: Risk-Averse Value Investing Strategies for the Thoughtful Investor
Book Review
Seth A. Klarman’s very limited print of “Margin of Safety” is in such short supply that used copies sell for between $825 and $1300 (as per latest check on Amazon).
Klarman explains the value investing philosophy, the logic of the value investing strategy, and why value investing succeeds over the long term. Klarman holds, and has indeed demonstrated by his outstanding investment performance, that the market is not always efficient. This means that, in the short run, market inefficiencies present the value investor with opportunities to purchase stocks at substantial discounts to their intrinsic value (i.e. buying stocks with a margin of safety). Klarman asserts that purchasing stocks with a significant margin of safety also serves to reduce portfolio risk. The value investing strategy calls on the value investor to hold the stocks purchased at a discount until the market bids up the price as the value or worth is recognized by the market. Klarman also describes that consideration should be given to selling existing stocks if better opportunities become available. Cash should also be held as necessary to take advantage of opportunities and/or in the event that there is a lack of current investment opportunities.
“Margin of Safety” is organized into three sections:
Where Most Investors Stumble
A Value-Investment Philosophy
The Value-Investment Process
Section 1 examines why most investor and other investment philosophies ultimately fail or underperform. Klarman is also quite critical of the investment industry and explains to the reader how the financial interests of others can negatively impact the individual investor. Klarman also uses the example of the junk bond mania that occurred in the 1980s and some readers may see this as dated; however, it was only to serve as a then recent example of how a mania and lack of fundamental analysis ultimately hurt many investors.
Section 2 explains the value investment philosophy and even introduces the technical aspects of valuing businesses (i.e. how to value stocks). Klarman asserts that value investors must first consider the risk of loss and avoid losing capital before even considering potential returns. Value investing is performed by analyzing individual companies (also known as a “bottom-up” approach). Valuation methods that are introduced include: discounted cash flow or net present value, private market, liquidation value, stock market value (with some major caveats!). Other valuation methods (or inputs into valuation) that have some significant shortcomings in the opinion of Klarman include: earnings per share, book value, and dividend yield.
Section 3 details the implementation of a value investing strategy. At the individual company or stock level, research and analytical processes are examined and a selection of specific types investment opportunities are presented. At a higher conceptual level, portfolio management and trading strategies are discussed as well as the process of selecting an investment professional.
What Klarman does particularly well is provide context for the investor. The environment in which the investor must operate is described and flags are waived at potential pitfalls. Klarman also does an excellent job of explaining why a value investing strategy can be consistently profitable while at the same time reduce risk. Finally, Klarman explain why market inefficiencies occur and ways that the value investor can capitalize on these opportunities.
“Margin of Safety” is a must-read for investors. Klarman’s book is straight-forward, honest, thought-provoking, and enlightening.
Please read more about the value investing theory of margin of safety.
Key concepts discussed:
- Margin of Safety
- Investment vs. Speculation
- Market efficiency vs. Market inefficiency
- Mr. Market
Book Information
Title: MARGIN OF SAFETY: Risk-Averse Value Investing Strategies for the Thoughtful Investor
Author: Seth A. Klarman
Publisher: HarperCollins
Publication date: 1991
Number of pages: 249
Review Information
Reveiwer: DeepValueInvestor.com
Date of First Review: December 2010
Updated:
Stars (9/10)
About DeepValueInvestor.com
DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
*** Learn more about value investing and follow value investing stock picks - sign-up for our free newsletter! ***
DeepValueInvestor.com regularly reviews books on deep value investing and value investing. Check out our dedicated page on value investing book reviews.
Copyright © 2010 by DeepValueInvestor.com. All rights are reserved.
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Deep Value Investing – Education
Here we’ll look at deep value investing definitions, examine deep value investing strategies, review the personal characteristics and traits of deep value investors, explore deep value investing tools, study deep value investing historical returns, and much, much more!
Keep up-to-date by reading the latest deep value investing news from around the world!
Deep Value Investing – Resources
Here you can find other helpful links to deep value investing tools, deep value investing professionals, world stock markets, various regulators, and more!
Deep Value Investing – Books and Reviews
A collection of deep value investing book reviews. Learn and read about the classics as well as modern deep value investing books.
Famous deep value investors share their knowledge and wisdom. In addition to deep value investing quotes, there is also a selection of quotes related to motivation, success and required personal characteristics.
Deep Value Investing – COATTAIL CORNER
“Coattail Corner” is our free value investing newsletter. ”Coattail Corner” will be dedicated to tracking the investments of famous deep value investors. Professional deep value investors are often required by law to disclose their portfolio holdings. Some deep value investors go further and engage the media to publicize their positions and highlight the investment attractiveness of the stocks they hold. ”Coattail Corner” will provide information on how to track the pros as well as provide selected information or articles on the portfolio holdings of professional deep value investors.