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The Mindset Of The Value Investor: Modern Value Investing

By Sven Carlin. Originally published at ValueWalk.

modern value investing Mindset Of The Value Investor

In the following video, Sven Carlin shares Shreya Kumari’s book summary of the Modern Value Investing book. The book is organized as follows: A) The mindset of the value investor, B) 25 tools to apply when analyzing stocks, C) 25 tools application example, D) Going beyond value investing.


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The Mindset Of The Value Investor: Modern Value Investing

Transcript

Good day fellow investors. I was contacted by Shreya Kumari, an MBA student from India that as an assignment for investing needed to do a review of an investing book, she picked modern value investing. She did a great job in here, video review. And then I thought, okay, she asked me for feedback. Well, she did a great job I taught Yes. And I want to share her review of the book with you. It’s very interesting and check out the book if you haven’t. Thank you.

Good morning. good afternoon, and good evening in regard to that, if you’re watching this video. So in this video presentation, I’m going to talk about a book named modern value investing by Sven Carlin. So firstly, I’ll tell you why the reason why I chose this book so while going through the book reviews on internet on Amazon, I came across that everybody everybody said that, this book in very simple terms helps you achieve your financial goals. And I’ll be probably earning next year.

I wanted to start early and use the compounding factor of investing. So, coming to the book. So, the book is divided into three parts. The first is talks about the mindset of the value investor should have have second talks about the technical tools you can use to achieve margin of safety. And third talks about going beyond value investing, that is lowering your risk and increasing your potential returns.

So coming to the part one, which talks about the mindset of the value investor, four things you need to keep in mind.The first is investing is done to achieve a future goal. So if your current life decisions are based on that investing, you probably your decision will totally be irrational. Because you won’t be able to take extreme decisions take have the courage to take extreme decisions according to the bargains available. Second is you have to be a contrarian.

If the market is doing very well just keep quiet and you should sell. And if the market is doing bad, and everybody is just selling, just wait for the appropriate bargain available that meets all your criterias and just buy. The third is that value investing is very boring because it requires thousands of research analysis. And the fourth is value investing is not correlated to stock market. So there may be few years when your stock may underperform but you will surely finish your marathon with satisfying returns that is achieving your financial goal.

So from these four understanding we can make out some characteristics of the value investor that is four the first characteristic is you should be able to differentiate between intrinsic value of the mark intrinsic value of the investment and the market created illusion pricing, the second is of value investors must know how to take advantage of other people’s emotions. Let me explain this with an example.

Suppose you are a partner in a business and the other partner every day is selling you his stakes at different prices. When he is happy he is charging high prices and when he is gloomy, his shop is ready to sell at a very low price. But you have the option to decline that offer because you know, tomorrow again, a new offer will come. So, same way the market works. And obviously it goes without saying that a value investor should be optimistic when everyone around him is being pessimistic.

So the book says that market is irrational. And that’s where behavioural finance comes into picture. The basis of behavioural finance is that people take very irrational decisions when it comes to their finances, which brings to light to theories, prospect theory and risk aversion theory. So the prospect theory states that people treat losses and profits very differently and investors base their decisions on perceived gains, not on perceived losses.

So we’ll understand this with an example which was in the book very good example. Suppose that two investment advisors advising about the same point. So the first says that there is an average 10% return, while the second advisor says that in the past decade there has been above average returns but few years before the average has started declining. So, according to prospect theory, mostly investors will choose the first advisor because they base their decision on perceived gains.

Second is loss aversion theory which states that people hate losing money. So, they treat they for them loss, loss and profit of the same amount they treated differently, losses affect them more even if the amount is same. When we talk about investing, the first thing that comes to our mind is just so, this in value investing the lower the risk, the higher is the potential return. Which is honestly very opposite to what we have learned what I have learned personally. So value investors face risk is permanent loss of capital and what markets defined as risk Just volatility and volatility is a friend of value investor. The most important measure of risk for value investor is the price, the value investor pays and the value he’s getting. So risk will be defined on a personal level it will be defined as not achieving your personal goal.

The next thing I’m going to talk about is expanding value investing mindset. So value investors should be able to distinguish between stock fluctuation and business reality. Sometimes stock prices have detached from the reality. Let’s take in a recession scenario where the stock prices are crashing and everybody’s selling at whatever price they can. Even the pharmaceutical companies share prices drops, but it’s a necessity. It’s a necessity good. So market constantly offers huge bargain investment opportunities. If you are able to distinguish between erratic market behaviour and underlying business fundamentals. Obviously optimism is the key. So you should buy the stocks whose values screaming at you even if the herd is blinded by the short term market drop. So this brings us to the end of part one.

The second part of the book talks about various tools to increase margin of safety. The point is to limit the probability of being wrong because in value investing, the main focus is on limiting the risk. So in order in because of time constraint, I’m going to consolidate various tools and provide our understanding. So the first is to find out the intrinsic value of the business. This can be done with different valuation method that is NPV, net present value, that is equal to present value of future cash flows minus stock price. So, when this value is positive, then only our investors should invest. Because value investing talks about increasing the margin of safety. So, we have to be very conservative while doing valuation.

The second method is liquidation. In liquidation method, we assume that the business is going to stop being a going concern. So, we realise the assets at the market value which is usually 30 to 50% less than what is registered in the balance sheet because again being conservative and we eliminate all the intangible assets. This is an old strategy but provides a good addition checking point when analysing investment.

The next from Modern Value Investing is we can also find intrinsic value of investment by using free cash flow methods. And also we can use return on invested capital. So, a higher the return on invested capital, the higher is the stability in a company and which in turns in first to a higher margin of safety. When we combine these components, we get a range of intrinsic values again the idea is to find a range and invest accordingly because, obviously, there can be no precision.

Three easy ways to calculate margin of safety. First is net cash per share value, divide the cash and cash equivalents minus debt divided by the shares outstanding and if the value of the share prices below the net cash, cash per share, so, we invest and also check the dividend sustainability by seeing it historically. If in case of any cyclical downturn or recession, how the company’s dividends reacted in form of any change from the competitor if the dividend was dried and any change from the competitor made the dividend questionable. So, obviously, there is generally no margin of safety.

The next category is the quantitative tools to analyse the risk of a company. So, let us start with finding a business moat which includes business moat means finding a defence which cannot be threatened by any other business some factors which can be used to determine business motor, low cost providers, high switching costs, brand value network effect and government support.

Second is analysing the management of the company, analysing the quality of earnings, analysing the cyclicity of the sector, which means if the seeing the demand supplied trend and if the supply applies constraint with demand growing, then we have a winner and also analysing the economy because recession really come. It may not be evident at this point of time, but it’s natural income and you should prepare your model in that way.

Next from Modern Value Investing, the third category is how to save yourself from value traps because value investing is very tempting, but majority of them are value traps. So, first of all, you should look for catalysts, which may be in form of mergers and acquisitions or increased operational efficiency, but anything which will unlock a future value. Secondly is you should avoid sectors which are overly competitive because there is no value left in them. Third is see the quality of assets in the balance sheet. The fourth is look inside activity of the company like if the price drops and its insiders are buying shares, which means that the employees have faith in the company and if there is more selling than buying, which means there is a fixed reason for that happening. Again we have talked about to take advantage of the market sentiment.

But the main question here is how and where could you find bargains like this? So, the answer to this question is start by looking into catalysts, which will give you a fair valuation, risk arbitrates invest in smaller mid cap companies because there is more value to be unlocked. Go global because internationally, there may be a volatility for some time, but in future, l provide potential returns. So, this brings us to the end of part two. So, there are many other concepts which go beyond value investing and the third part talks about it. There are many other concepts which are used in lowering the risk.

So the first is portfolio management every investment has its own individual risks, but a good portfolio lowers the overall risk. The second is a value investor should also trade because it likes you to keep in touch with the market and allows you to take advantage of market irrationalities. The third is a value investors should know when to sell a stock. Fourth is the lowering of risk can be done through hedging because hedging provides an it’s like an insurance cover. So hedging diversification as a hedging, where you diversify in non related asset hedging against inflation by Including a risk free asset in a portfolio hedging to limit currency risk by having an well diversified international portfolio, liquidity risk, where having a liquidity cushion allows you to take action in case of market rationalities.

There is a new concept which the author has introduced where everything possibly wrong can go on. So, it is divided into four economists scenarios and in that scenario, what type of asset you should invest in. The first scenario is where the economy is growing and the inflation is below expectation. Obviously, in that scenario, you invest in stocks. The second scenario is when the economy is growing and the inflation is also growing. So in that scenario, you can go for emerging market bonds or commodities are because they will provide yield. The third scenarios where the economy is going down and inflation is increasing. So, in that case, you can obviously go for gold because the prices will be high. Fourth scenario when the economy is going down inflation is also going down in that case you can invest in treasuries.

The main idea of all weather portfolio is key point rebalancing your portfolio. So, this brings us to the end of the book. So, this is the book modern value investing, probably I should have shown it earlier. But so, the things I liked about this book was every tool every concept is an explained with an example the tools which the technical value investing tools, the author explained, but explained it with the Daimler shares and balance sheet and everything. So what I learned is you should never be influenced by a market fad. You should do your due diligence and it requires immense lot of pressure different type of analysis and you should also have the patience when to buy and right time to buy. So thank you for listening.

The post The Mindset Of The Value Investor: Modern Value Investing appeared first on ValueWalk.

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