Investing style is a religion

[Value Collector]

Imagine a company ABC that has great earnings growth. You do your value calculation, and you decide it's worth $30. Guess what! It's trading exactly at exactly $30 today!

A Growth Investor would say, "Buy!". He's paying a fair price for a good asset. A Value Investor would say, "I demand a 30% discount below the $30 calculated fair value". He wants a discounted price.

You are assuming a value investor wouldn't be happy paying a fair price, I pay what I believe to be a fair price for company's all the time, But how can you know what the fair price is if you are not basing your opinion on value?

You are stuck in this thought that "Value investors" are only looking for companies with high book value or something.

That is flawed thinking, often we are just trying to work out what a rational price for a company is based on all the factors including growth prospects, So that we can find good investments and not over pay for them.

Do you honestly think all value investors are totally ignoring growth prospects?

what this video, Roger Montgomery is a value investor, and you will see with his formula he is calculating expected growth into his valuation.

 

[luutzu]

It seems you've interpreted "fair value" as already including a discount.



Morningstar and I use "fair value" to mean what the company is worth. You then take your discount after that - your margin of safety.

Yea I made that assumption for the example above. Nothing wrong with what you and morningStar is doing... just a matter of doing it before or after the calculation.

 

[galumay]

Yep, value and growth are definitely intertwined for me. I need to know the value of a business in order to decide whether the price has a sufficient margin of safety, but i would prefer to buy growth businesses where possible.

I am looking for businesses that have a proven record of high returns on invested capital, some form of competitive advantage, (they usually go hand in hand), potential for sustainable growth in the foreseeable future, and that are trading at a price which represents a discount to value sufficient to provide that margin of safety.

I suspect that the OP may be using 'growth investor' in the sense of a trader, as in momentum, thats not what it means to me. A growth investor is someone who is looking for businesses where they are in the early stage of development and maybe cash flow negative, but the business analysis on a qualitative basis implies that there will be strong revenue growth and a move into a cash flow positive and profitable business in the future.

I have a number of businesses in this category in my portfolios, my valuation is still important, but the analysis is a combination of value and extrapolation of growth.

 

[luutzu]

You are assuming a value investor wouldn't be happy paying a fair price, I pay what I believe to be a fair price for company's all the time, But how can you know what the fair price is if you are not basing your opinion on value?

You are stuck in this thought that "Value investors" are only looking for companies with high book value or something.

That is flawed thinking, often we are just trying to work out what a rational price for a company is based on all the factors including growth prospects, So that we can find good investments and not over pay for them.

Do you honestly think all value investors are totally ignoring growth prospects?

what this video, Roger Montgomery is a value investor, and you will see with his formula he is calculating expected growth into his valuation.

Monty is wrong about WOW being a quality business.

That's not just hindsight after his 2010 forecast there either.

His figures for equity is a bit off.

I have $7057.3M for 2009 equity. His was $6812.5M

Net profit was $1860 vs his $1835.7.

Not a biggie, but the trend from 2000, or in my case 2001... has been downwards to 2009. i.e. from 2002 to 2009, Net return on average equity was 33.67% then dropping down to 27.6% in 2009.

The DuPont ROE gives a higher figure, but still the trend is down. So by that ROE measure alone, WOW was definitely not doing as good as it used to.

That's not saying it's a bad business. But it's no WalMart.

 

[Value Collector]

Monty is wrong about WOW being a quality business.

That's not just hindsight after his 2010 forecast there either.

His figures for equity is a bit off.

I have $7057.3M for 2009 equity. His was $6812.5M

Net profit was $1860 vs his $1835.7.

Not a biggie, but the trend from 2000, or in my case 2001... has been downwards to 2009. i.e. from 2002 to 2009, Net return on average equity was 33.67% then dropping down to 27.6% in 2009.

The DuPont ROE gives a higher figure, but still the trend is down. So by that ROE measure alone, WOW was definitely not doing as good as it used to.

That's not saying it's a bad business. But it's no WalMart.


View attachment 87906

WOW is a great business, just masters fiasco through off montys valuation, hence why you need a margin of safety, because you never know.

 

[Value Collector]

It seems you've interpreted "fair value" as already including a discount.



Morningstar and I use "fair value" to mean what the company is worth. You then take your discount after that - your margin of safety.

How exactly is the “growth investor” determining “fair value”, if he isn’t using some sort of “value investing” approach.

 

[Zaxon]

I am looking for businesses that have a proven record of high returns on invested capital, some form of competitive advantage, (they usually go hand in hand), potential for sustainable growth in the foreseeable future, and that are trading at a price which represents a discount to value sufficient to provide that margin of safety.

Sounds like an excellent approach to me.

I suspect that the OP may be using 'growth investor' in the sense of a trader, as in momentum, thats not what it means to me.

I try not to have a personal definition, since that's where everyone gets confused and "value investing" and "growth investing" then mean vastly different things to different people. And let the confusion begin.

So you go to the dictionary, or in this case, say Wikipedia.

 

[galumay]

Well probably not Wikiedia!

Does it really matter? People use all sorts of terms all the time with little understanding of what they really mean or how they should be used. The world is full of "value investors" who have no idea how to value a business, and "growth investors" who use that term because they are buying businesses whose price is "growing"!!

What matters is what someone is actually doing and why.

 

[luutzu]

WOW is a great business, just masters fiasco through off montys valuation, hence why you need a margin of safety, because you never know.

It's slightly above average. Not a bad business. Just not a high quality one. There are other seriously awesome retailers I've seen, both aren't in Australia.

But WOW's performance and management is pretty good. Could have been better if it weren't due to Australia's small population, large distances...

Monty's pricing was a couple bucks higher than a mechanical application of Graham's for an established business like WOW. But can't fault the guy for Masters though.

I'm not quite sure why he'd need to value dividend and retained earnings or such separately. But yea.

 

[Zaxon]

This thread asked, "Are the different styles of investing really more like a religion than a science?" I use religion in this context to mean a fervently held set of beliefs and practices without objective scientific evidence to support them".

Secretly, I was hoping for people to share studies which show, over a long period, Value Investing, Momentum Investing, or Trading, etc has proven to give the highest rate of return over a wide cross section of market conditions, and here's the data to support that.

What I got, overwhelmingly, was comments like, "Everyone else's understanding of <insert investment style here> is wrong! I know the only true way of how this works. My guru <insert name here> says <x> therefore you're all wrong." Obviously, I'm exaggerating a bit for effect here, but these responses seem very "religious" to me.

Now I'm not "having a go" at any individual. That's not my purpose here. My conclusion, based on the tiny sample size of this thread, is that yes, people invest more like they're following a "religion", rather than following a set of methods objectively proven to give you the greatest rate of return. Perhaps because the science of investing is still largely unknown. And perhaps because human nature just works that way.

 

[galumay]

"Are the different styles of investing really more like a religion than a science?"

No, because as a few of us have tried to explain, the different styles of investing are based on quite different elements of the market. Different styles will work better in different parts of a market cycle, but also markets are dynamic and complex, nothing is ever exactly the same as it was in the past and new things that have never happened before happen for the first time.

If you look you will find studies to support just about any investing strategy - and others to disprove them! The systems are simply too dynamic and complex to draw ridiculously simple conclusions.

Your obsessing about categorising investing as religion or science is silly IMO, its neither and no one is claiming its one or the other.

If there were one investing style that was objectively proven to give you the greatest rate of return it would be being practised by everyone. (and the conundrum is that it would then probably stop working!)

There is no science of investing, just like there is no religion of investing.

 

[luutzu]

This thread asked, "Are the different styles of investing really more like a religion than a science?" I use religion in this context to mean a fervently held set of beliefs and practices without objective scientific evidence to support them".

Secretly, I was hoping for people to share studies which show, over a long period, Value Investing, Momentum Investing, or Trading, etc has proven to give the highest rate of return over a wide cross section of market conditions, and here's the data to support that.

What I got, overwhelmingly, was comments like, "Everyone else's understanding of <insert investment style here> is wrong! I know the only true way of how this works. My guru <insert name here> says <x> therefore you're all wrong." Obviously, I'm exaggerating a bit for effect here, but these responses seem very "religious" to me.

Now I'm not "having a go" at any individual. That's not my purpose here. My conclusion, based on the tiny sample size of this thread, is that yes, people invest more like they're following a "religion", rather than following a set of methods objectively proven to give you the greatest rate of return. Perhaps because the science of investing is still largely unknown. And perhaps because human nature just works that way.

You read Buffett's "Superinvestors of Graham and Doddsville"?

It's not about guru or secret formula or some unique art. Investing is a science, just its subjects are never constant so the scientist investor have to adapt his knowledge to the investment opportunity.

Say value investing state that you should only buy a stock valued at $1 for $1.

If a $1 stock is offered at $1 or less, then obviously they're going to do well.

But how can anyone be certain that a $1 stock is actually worth $1?

It might appear to be $1 now, but a few years down the track unexpected things happen. Might work out really well, might work out badly. So in hindsight, what appear $1 would have actually been $0.50 that turned out, through luck and new business venture, to be $2. etc. etc.

That's not saying a business can't be valued. It can't be valued precisely. Just an approximate.

But there are investors and university professors teaching perfectly smart people how to precisely predict the future of a business, down to the decimal places.

 

[Zaxon]

Investing is a science, just its subjects are never constant so the scientist investor have to adapt his knowledge to the investment opportunity.

Buffett has said that the same investment principles he used 50 years ago are exactly the same that are right for today. What is that you think we need to constantly adapt to? Market cycles?

But how can anyone be certain that a $1 stock is actually worth $1?

That's not saying a business can't be valued. It can't be valued precisely. Just an approximate.

For sure. Which reminds me of the "I don't need to know a woman's exact weight to know she's overweight" comment that Buffett and Graham have used.

Value investing I think has a high chance of being an outperforming investment style. And Buffett has demonstrated exactly that. But "cut your losses short and let your profits run", so more of a momentum style, also could have an outperforming edge.

 

[galumay]

Buffett has said that the same investment principles he used 50 years ago are exactly the same that are right for today.

...for him.

Value investing I think has a high chance of being an outperforming investment style.

Maybe, but most so called value investors have a high chance of underperforming based on past performance. There isnt a holy grail of investment style, otherwise everyone would be doing it. What works for you may not work for me, you have to match investment style with psychology, personality and conviction.

Someone whose personality is suited to short term market action, who sees shares as a commodity in themselves, who believes TA is an indicator of future price action, is going to make a hopeless long term value investor!

"cut your losses short and let your profits run"

How do you decide when thats the correct action? I made huge amounts of money averaging down into a business I had a very high conviction about, my biggest wins have come from averaging down. I have sold out of businesses that were solid gains for me, but something changed with the business that made me sell the winner - and they went into a slow, long price decline.

In other cases my decision to hold onto winners has cost me nearly all the invested capital - SGH being the prime example.

 

[Value Collector]

I'm not quite sure why he'd need to value dividend and retained earnings or such separately. But yea.

Because a company that earns 25% return of equity, and retains 100% of earnings and deploys them into further investments that also earn 25% is worth more than a company that pays out all its dividends.

eg.

If company A - has $1 of equity, and it earns 25% return on that equity, and pays the whole $0.25 earning as a dividend, it will probably never grow, So if I want a 10% return I can only pay $2.50 for the company, because my 10%pa earnings have to come from dividend alone.

However,

If Company B - also has $1 of equity, and also earns 25% return on that equity, but it retains 100% of its earnings and deploys it into investments also earning 25% return, it will grow earnings over time as its equity base expands via retained earnings, So I can pay up to $5.20 for it and still get my 10% return I want.


------------

Which would you be willing to pay more for,

1, A bank account with $100 in it, paying 25% interest that pays out the interest every year in cash to you. (that you have to bank into you normal account at 2%)

or

2, A bank account with $100 in it, paying 25% interest that it retains and compounds at 25%



This is the type of thing value investors take into consideration, hence why I say growth is part of being a value investor, we are constantly weighing up companies growth potential and factoring it into the price I am willing to pay, and my prediction of what companies will be worth.

 

[luutzu]

Buffett has said that the same investment principles he used 50 years ago are exactly the same that are right for today. What is that you think we need to constantly adapt to? Market cycles?

For sure. Which reminds me of the "I don't need to know a woman's exact weight to know she's overweight" comment that Buffett and Graham have used.

Value investing I think has a high chance of being an outperforming investment style. And Buffett has demonstrated exactly that. But "cut your losses short and let your profits run", so more of a momentum style, also could have an outperforming edge.

The principles don't change. You don't adapt the method and principles.
But you ought to adapt to the opportunity you see.

That is, the method in itself allow for that adaption in the calculus. You know, Art of War stuff.

Alright, that still sounds like those DCF nonsense. Let's illustrate....

Say you generally do not buy stocks above 20 times earnings because that implied an expected annual growth of 5.75%. A figure that's not impossible, but somewhat rare.

But then you figured the business have a pretty good chance of matching or exceeding that implied growth rate. Quite confident about it.

in such situation, you're not adapting your principles and methods. You simply adapt to the opportunity.

That's why Graham bought GEICO. I mean, from my reading of Munger and Buffett they reckon Graham was abandoning his value method, going for the growth stocks and so win big. I'm sure they know better just I reckon Graham know GEICO very, very well... I think his purchase also mean he has some influence on the board... So you adapt.

The more confident you are about the future prospect of a business, the higher the price you're willing to offer... and that higher price would still be "value".


Cut your losses and let the profit run... yea... if you could be sure the current loss is a loss and profit is an actual profit.

Sometime the market just doesn't know what it's doing and your loss is just an opportunity to buy. Sometimes it's an actual loss and sticking around is not advisable.

Sometime, like APA, haha... you hit a series of lucks and reckon the profit is from a wonderful business.

 

[luutzu]

Because a company that earns 25% return of equity, and retains 100% of earnings and deploys them into further investments that also earn 25% is worth more than a company that pays out all its dividends.

eg.

If company A - has $1 of equity, and it earns 25% return on that equity, and pays the whole $0.25 earning as a dividend, it will probably never grow, So if I want a 10% return I can only pay $2.50 for the company, because my 10%pa earnings have to come from dividend alone.

However,

If Company B - also has $1 of equity, and also earns 25% return on that equity, but it retains 100% of its earnings and deploys it into investments also earning 25% return, it will grow earnings over time as its equity base expands via retained earnings, So I can pay up to $5.20 for it and still get my 10% return I want.


------------

Which would you be willing to pay more for,

1, A bank account with $100 in it, paying 25% interest that pays out the interest every year in cash to you. (that you have to bank into you normal account at 2%)

or

2, A bank account with $100 in it, paying 25% interest that it retains and compounds at 25%

This is the type of thing value investors take into consideration, hence why I say growth is part of being a value investor, we are constantly weighing up companies growth potential and factoring it into the price I am willing to pay, and my prediction of what companies will be worth.

That doesn't make much sense.

I mean, technically, mathematically it does. Just that if you see the ownership of a business as owning the entire business and you're its one and only shareholder... it doesn't really matter whether the company pays out dividends or keep all its earnings.

The company earns x so its value is y. It splitting of that earnings out as dividend etc. shouldn't affect the value of the company.

I mean it certainly affect the individual holder depends on their tax position. So I see where he's coming from.

 

[Value Collector]

Just that if you see the ownership of a business as owning the entire business and you're its one and only shareholder... it doesn't really matter whether the company pays out dividends or keep all its earnings.

.

Of course it matters, I think you are missing the entire point.

The Point is, a company that retains earnings and deploys them into new assets earning a high rate of return of say 25%, is worth more than a company that pays them out as a dividend.

In rogers example of woolies, woolies had a return on equity of 26%.

If woolies pays out 70% of its earnings and invests the other 30% in opening new supermarkets and bottle shops earning 26%, then we have to factor the growth into our valuation.

When Roger was breaking it up between retained earnings and dividends, he was simply making an allowance that the retained portion was going to add to equity and grow earnings at a good rate.


-------------------------

if you want a 10% return

$1 of equity earning earning 25% is worth $2.50 to you ( if all earnings get paid out)

but,

$1 of equity earning earning 25% is worth $5.20 to you (if all earnings are retained compounding at 25%)

but,

Companies like woolies that pay out only 70% while retaining 30%, you need to break up the valuation a bit to account for the pay out ratio.

so you take

$0.70 of equity x 2.5 = $1.75 (this portion of equity has earning paid out)
$0.30 of equity x 5.2 = $1.56 (this portion of equity has earning retained)

Total - $3.31 Fair value of $1 of equity compounding at 25%, paying out 70% of earnings.

So you wouldn't want to pay more than that for the $1 of equity unless you had good reason to think ROE will rise higher than 25%, and you would probably want a margin of safety because sometimes Masters situations happen.

 

[gaius]

...
It's curious to me that after a couple of centuries of investing, we still have to rely so much on belief rather than on hard, actual facts.

I don't believe in neither value/momentum religion. Those are for fundamental/technical academia to complicate things and make themselves look smarter. The market always goes up, it is dead simple, anyone could make money. That is why both value and momentum religion believers believe their strategy works.

 

[luutzu]

Of course it matters, I think you are missing the entire point.

The Point is, a company that retains earnings and deploys them into new assets earning a high rate of return of say 25%, is worth more than a company that pays them out as a dividend.

In rogers example of woolies, woolies had a return on equity of 26%.

If woolies pays out 70% of its earnings and invests the other 30% in opening new supermarkets and bottle shops earning 26%, then we have to factor the growth into our valuation.

When Roger was breaking it up between retained earnings and dividends, he was simply making an allowance that the retained portion was going to add to equity and grow earnings at a good rate.


-------------------------

if you want a 10% return

$1 of equity earning earning 25% is worth $2.50 to you ( if all earnings get paid out)

but,

$1 of equity earning earning 25% is worth $5.20 to you (if all earnings are retained compounding at 25%)

but,

Companies like woolies that pay out only 70% while retaining 30%, you need to break up the valuation a bit to account for the pay out ratio.

so you take

$0.70 of equity x 2.5 = $1.75 (this portion of equity has earning paid out)
$0.30 of equity x 5.2 = $1.56 (this portion of equity has earning retained)

Total - $3.31 Fair value of $1 of equity compounding at 25%, paying out 70% of earnings.

So you wouldn't want to pay more than that for the $1 of equity unless you had good reason to think ROE will rise higher than 25%, and you would probably want a margin of safety because sometimes Masters situations happen.

Just rewatched the video above...

I'm a bit slow here, but what!?

Say WOW earns $X. According to Monty....

If WOW pays all of that earning out in dividends, it is worth less [~$16].

But if it were to keep all that earnings, it's worth more [~$36?]

It's the same company, earning the same amount in both scenario. So how is it valued less in an objective sense?

Say I own WOW all by myself. And the board decided to hand over the year's profit. All 100% of it. Or hand over 50%... either way, WOW still earn the same amount, so its value is the same as a business. True?

The only difference would be my tax position, and possibly what I decide to do with the cash. So if I put all the dividends on a night out at Star Casinos, that dividend is soon worth zero. If I put it in a savings account, close to zero... but it does not affect WOW's earnings, and hence value, as a business.


Put it another way. Say WOW pay each of us the same dividend. I know a good accountant and having made losses over the years (not biographical ), I pay zero tax on that divvy. You on the other hand pays a few cents in taxes on the divvy.

That shouldn't mean that WOW's dividend is any different when it pays to you and to me. It's the same amount, just worth differently on that individual, after tax basis. But that basis shouldn't influence an objective assessment of what WOW is worth.

Don'tknow... I find it to be a strange way to value a business. Like I said, I do get that for each shareholder the value of dividends and such will be different. But that doesn't have anything to do with the business' own value.


btw, how did he/yuo come up with that 10% required return mean $1 is worth $2.50 etc.?