WCM Educational Recap #10 — Intro to Value Investing

Recapped by Amy Zado

Welcome back to the WCM blog! Today we’ll be exploring the history and fundamentals surrounding value investing. Stay tuned for the end to see the finalists for the Equity Report Challenge! But first, the week in review:

Tesla cuts the prices of their two highest selling models by up to 20% to help make them more affordable to consumers and more eligible for US tax credits. This could be an indication that they are losing market share due to up-and-coming EV companies, and developed companies moving into the space. Within less than a week, Ford cut prices in response.

Investment Approaches

The two main ways we determine a company’s value is through its intrinsic value, the fundamental objective value of a company based on facts like assets, earnings, and profits, and its market price, the market quote based on speculative factors and people’s sentiments and decisions. These are determined by the following factors:

• Speculative Market Factors tend to by more psychological or manipulative
• Speculative/Investment Future Value Factors look at the management team, company reputation, the competitive landscape, the company’s economic moat, and possible/probable changes in volume, price, and costs
• Investment Intrinsic Value Factors tend to focus on cash flow determinants such as earnings, dividends, assets, capital structure, terms of issue, etc.

Growth Investing is the investment in securities which you think have potential for rapid growth and a strong market hold in the future. They may or may not be undervalued now, and require the consideration of all future events in the market. Here we typically see attempts to maximize profits in a short time frame using aggressive tactics with elevated risk.

Value Investing is the process of determining a security’s intrinsic value to purchase it when the price is low. The intrinsic value will be realized when market sentiments change so outsized returns will be achieved. With value investing, we follow the random walk hypothesis, meaning that a stock’s past movements have no regard on their future movement.

A reminder that a good investment is a good company at a good price. Qualitatively, we look for reliable management, high customer retention, and barriers to entry. Quantitatively, we for low multiples, cheap relative to peers, strong margins, and a growing top-line.

Price vs Value

Value investing brings up the differences between these terms. Price typically reflects market sentiments and follows the efficient market hypothesis. This does not fully capture the true value of a company, because changing price is the result of short term fluctuations in the market influenced by favorable facts and opinions, rather than a true understanding of a company’s potential.

Bubbles distort the relationship between price and value so a large discrepancy between market value and fair value is created, moving a security from attractive, to attractive at any price. Their life cycles look like:

• 1. Stealth phase: smart investors begin to invest
• 2. Awareness phase: institutional investors begin populating
• 3. Mania phase: many public investors heavily influenced by psychological factors
• 4. Cool-down phase: people realize it’s overpriced and start selling off shares
• 5. The market returns to average

So, What’s Important for Value Investing?

Second Level Thinking

• Someone that capitalizes on a unique edge such as superior insight, intuition, a sense of value, or an awareness of psychology that beats the market
• This concept is dependent on market inefficiencies and often involves non-consensus views alongside accurate positions
• Key considerations of these thinkers include: the consensus view, the bullish or bearishness of a price, and the range of likely future outcomes

Identifying a Bargain

• Bargains often occur when the company is questionable on the surface, is unpopular/underappreciated, is inappropriate in traditional portfolios, was recently the subject of disinvestment, or has assets that are difficult to understand
• The process often is: look at a list of potential investments according to the return goals and risk tolerance, estimate the intrinsic value, compare it to the market, and understand the associated risks

Contrarianism

• Generally regarded as doing the opposite of what the majority is doing, which is difficult as sometimes it’s hard to see beyond your beliefs or a market that’s been over/underpriced for years
• The herd often sticks with stable long-term structural growth and a high investor appetite but the most underappreciated stocks (and therefore best value investments) have strong long-term structural growth with low investor appetite
• The most profitable investment is when you buy and everyone else is selling, and then you sell when everyone else is buying

How Do We Play a Winner’s Game?

In this concept, winners try to maximize returns, while losers try to minimize losses. A defensive investor understands that unprofitable investments will occur, but the loss can be minimized through due diligence, high standards, and high margins of safety. We must also understand that the market acts as a pendulum, going from bull market stages with forward looking investors, to bear market stages where some thoughtful investors realize things could go bad and others follow. To be a winner, we must best balance the risk of losing money, with the risk of missing an opportunity.

Follow Ben Graham — the Grandfather of Value Investing

• Focus on stocks at prices that reflect dividend yields that would beat the market
• The lower the price, the higher the margin of safety

Patient Opportunism

• This is the strategy of waiting for a bargain, obvious over or under pricing, to invest
• Often involves waiting for investments to come to you as these will often outperform the market
• Generally, these investors will recognize the condition of the market, react opportunistically, and decide on future actions accordingly

Warren Buffet’s Philosophy

• Make a losing investment, miss a profitable investment, make a profitable investment, repeat
• The only real penalty is making losing investments so it’s better to be careful

Understanding Your Environment

• You always want to look for profitable opportunities with controlled risk, so take on risk when others don’t as long as you’ve understood the factors at play and have conviction in, and justification for your beliefs
• Note that in a low-return environment, going for high returns will result in more risk

Equity Report Challenge Results

First Place: Affan Bhimani (RNG)

Second Place: Matthew Engleman (TTMI)

Third Place: Jonah West (AMCX)

General Feedback

• Overall, we saw very comprehensive valuations and models with clear support for price targets, an in depth understanding of the business, industry, and competitive positioning, and a strong explanation for macroeconomic headwinds and tailwinds
• In future, try to focus more on your variant second-level view of where value can be derived from the business, rather than why it’s a good business, make sure your thesis points are quantified as key drivers in the DCF models, and make sure you check your work for small grammatical, formatting, and spelling errors

Thank you to everyone who participated! The Educations team was very impressed with all of your hard work!