Friday, May 25, 2018

All About Price: Introduction & Valuation of Value

In our everyday lives, there is one attribute that you will see, hear, use, ponder and gawk about most of the time. Yes, that attribute is price. Whether you are comparing on the same item across different places, different items in the same place, or different items across different places, the notion of price will always be there.

Zooming into the financial markets, the price of the financial instruments will be the first thing you will encounter; the bid/ask figures on your trading platform, the ticker tape shown on most business news channels, etc. There is no way you could invest or trade without ever looking at the price first.

Throughout this intermittent series about price, we shall look into its concept and context, and how it affects us in the world of investing and trading in terms of perceptions, decisions and results.

First up we will talk about the valuation of value.

Price vs. Value

“Price is what you pay. Value is what you get.” – Warren Buffett, 2008 Letter to Berkshire Hathaway shareholders.

This saying made by the ‘Oracle of Omaha’ is often quoted in most investing communities, particularly value investors. In gist, the share price of a company does not necessarily reflect its underlying value. Price and value will fluctuate over time, and along the way the price will go above, below or remain the same with the corresponding value. Value investors would love to get their company shares when the price goes below the value, as they are viewed as a discount, ceteris paribus.

Valuation Methods

The intrinsic value is considered to be the widely accepted value of a company in most investment literature, and it is calculated using the discounted cash flow (DCF) method (read up from Investopedia here). However, others use a variety of valuation parameters, such as book value or net asset value (NAV), net current asset value (NCAV) (read up from Investopedia here), etc. Furthermore, the investors may use one, some or all of the valuation methods to come out with their own aggregated value.

So what does this mean? We would have a whole range of values popping up by different value investors using various valuation methods on the same company at a given point of time. In other words, a company could have many values, depending on how it was looked at.

For example, Company A’s current share price is at $1.00. Investor X valued the company at $1.20, so Company A is viewed as a bargain. On the other hand, Investor Y used another valuation method and felt that Company A is worth only $0.80, thus Company A is expensive.

And The Point Is?

While the quote by Buffett holds true, value is still subjective depending on how the investors arrive at their numbers. The myriad of price points generated by this range of derived values, coupled with other participants that do not use any valuation method at all, partially provides the liquidity of the buying and selling in the financial markets.

On another note, in my ebook, I used NAV and Price-to-Earnings (P/E) ratio valuation as part of my selection criteria, but you could also use other methods as you deem fit. Valuation is just one part of fundamental analysis, and there are other criteria and requirements to think about when selecting what to buy or sell.

Sunday, May 13, 2018

An Intervention and Some Lessons Learnt

While on a weekend getaway a couple of years ago, I received a message from a friend, whom I shall name “H”. H was a relatively new investor and wanted to seek my opinion on a blue chip company whose share price had fell drastically. From H’s entry price, the fall was about 40%, and H was worried about holding it.

As I did not bring my laptop or tablet along, I had to use my smartphone (and the hotel’s free Wi-Fi) to do some rudimentary research on this company. After a few rounds of reading from a small screen, the factors that contributed to the fall was due to sectorial (namely oil) and customer risks. Yet despite these setbacks, fundamentally wise the company still looked healthy, and some parameters looked promising, especially on the NAV and dividend yield.

Usually I do not do “what-to-dos” on other people’s investments, but this incident was one of the few that I came in, noting H’s desperation. I texted back H and recommended to buy up the same number of shares that H had at that fallen price, thus making an averaging down move. Either way, H could buy up the shares on the cheap, or alternatively H could just sell them off when it neared or reached the average price, thus minimizing the loss.

I did not follow up until some two months later, when the shares did reach near the average price. I asked H about the status of the shares. To my surprise, H told me the shares were sold off just a few days after my recommendation, overwhelmed by fear and panic. And as expected, H regretted the sell decision back then.

The above true story provided some interesting lessons for H, and I shall share with you what they are.

Lesson 1 – Do Not Panic

It is natural to feel panicky when your investment securities had gone south. After all, this behaviour is associated with the term “loss aversion” (coined by renowned psychologists Daniel Kahneman and the late Amos Tversky), in which the impact of a loss of an amount is felt greater than a gain of the same amount. While nobody likes losses, the key thing is to remain calm and detached from emotions. Gains and losses are part and parcel in the investment journey.

Lesson 2 – The Loss Is Not Realised Yet

While some of us will go ga-ga with the loss of capital, as long as it is not cashed out, it is still not realised yet. Unrealised losses in your portfolio are deemed as paper losses, so do not be too uptight about how much you MIGHT lose. 

Lesson 3 – If The Fundamentals Are Healthy, Why Sell

If the share price suddenly took a nosedive, it is logical to find out what was going on with the company. Most of the time, some bad news or some poor financial numbers are the causes of the downward heading, and these must come to your attention. After analysis, if you conclude these events are non-threatening or having a short-term only impact, then it is safe to keep the shares.

Lesson 4 – View Them As A Sale

If a fundamentally sound company’s share prices go down, what would be the next step? Buy more, of course! The valuations and the yield would be seen as a bargain, and you could deploy cash from your Bedokian Portfolio or excess spillover from your emergency fund to buy them.

Remember not to have a knee-jerk reaction when things do not go your way. Keep calm and adopt different perspectives to the situation.