As we know by now, financial literacy is an important component of value investing. Coming a close second is company analysis.
As a value investor, it is always important to do your homework on the stock that you want to invest in. Value investors read and understand annual reports carefully, so that they can assess how management addresses those critical areas arising from external changes that significantly affect companies. This is because the management serves as the brain of the company, i.e. they respond to the endless changing environment and must be able to fulfil their role in navigating the company to the next level of success.
Questions you as a value investor should seek answers to include things like the quality of the assets that have been invested to build or strengthen the company’s competitiveness, compensation plans that have been put in place to retain key and talented personnel, and so on.
By looking at the bigger picture of the business, you would then be able to select the stocks suitable for investment. Things to look for would include (but are not limited to):
- the organization’s competitive position;
- its’ product or service trends; and
- economic and technological forces that affect its future value.
In essence, value investors focus on individual companies, reviewing their history of growth, corporate announcements and news inside out, and attending their annual general meeting and extra-ordinary meeting to raise material questions if appropriate. They gather these findings prior to the determination of a stock’s fair value that meets their selected criteria.
It sounds simple and logical, yet it is not easy. This is just one part of the process, because once the true value of a company has been determined, value investors will have to look for a buying opportunity. This means that a value investor will only buy stock in a target company if they can execute an order below the fair value price.
The question thus arises whether such bargain arises in the market. Although such stocks are in existence even in an efficient price market (where their potentials are often unnoticed), one would still need insightful information to make accurate assessment of the stocks’ fair value.
It doesn’t end here, of course – the third and most critical component is the strength of mind of the value investor.
Or to phrase this statement another way, how many have the strength of mind to remain unshaken by a market nosedive or a threatening global event?
The reality remains that the stock market is a psychological monster. Having done all this work in preparing oneself with research and careful study, the mind can play tricks on an investor when he or she observes the extremely chaotic and choppy trends the short-term market displays. It takes a lot of strength to remember that long-term trends rely on the fundamentals, and one simply must be able to ride out the market in working towards achieving ones’ goals.
The value investor is therefore one who has cultivated discipline to be better skilled investor. He or she acts contradictory to other investors accumulating bargain stocks after downside panics, holds on while the market climbs and rebalances back to his or her asset allocation while everyone is bragging about their gains.
In this sense, a value investor needs the “know how” to stay ahead. Next week, I’ll be sharing about the intelligent approaches and sound reasoning value investors apply before buying a particular stock.