Global Value Investing

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A multifaceted approach to value investing with stock valuation based on intrinsic value estimated from cash returns, appraised value of assets, and other facets of value.

 

 

Frequently Asked Questions and Answers

 

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Frequently Asked Questions (FAQs)

FAQs and answers are more a reference than a tutorial. Yet if you read carefully, they can serve as a fairly comprehensive introduction to investing. For convenience, the questions appear first with links to their answers.

Q 1. Where do I get money to begin investing in the stock market?

Q 2. Value investing and growth investing outperform one another over different historical periods and over periods of different lengths, from individual years to three, five, and ten years. Does this mean that an investor needs to first pick the approach that is expected to be best for the investment time horizon relevant to individual needs?

Q 3. I am an individual investor with my only stock holdings in a self-directed retirement account through my employer. How can I practice intrinsic value investing?

Q 4. Where do I get information about the investment objective and the investment method or style of particular mutual funds?

Q 5. Although I do not know my IQ score, I know that I am not above average. I do not feel competent enough to appraise companies by the method of intrinsic valuation. How can I benefit from intrinsic value investing?

Q 6. Should I pick stocks (choose investments), pick stock pickers (choose investment managers), or pick stock-picker pickers (choose a financial adviser)?

Q 7. I prefer to find a financial advisor who could identify and recommend investment managers who truly follow the intrinsic value appraisal method. Can you recommend someone in my geographical area?

Q 8. What difference does it make how a financial advisor is compensated?

Q 9. What is the CFA program?

Q 10. I have an IQ score in the top one percentile, but I do not wish to select my stocks. How can I find an investment manager with a high IQ who truly practices pure value investing?

Q 11. I have an IQ score in the top one percentile, and I wish to select stocks, bonds and mutual funds based on my own research. Is there any advantage to selecting individual stocks and bonds as opposed to selecting stock mutual funds and bond mutual funds?

Q 12. What are some indications that a mutual fund is a true "Pure Intrinsic Value" fund? Is there an organization of mutual funds similar to the "100% No-Load Mutual Fund Council" to verify the representations made by member mutual funds in their prospectuses?

Q 13. I screen stocks using economic "fundamental" criteria based on company-reported external accounting data such as net tangible assets per share. I thought that this was practicing value investing. It seems that I have not even begun to do the in-depth analysis required to determine whether a low relative price was also a low absolute price for no reasonable cause. This is discouraging because there is much tedious, arduous work involved in valuation as opposed to screening. Is there a service that provides the results of valuation analysis?

Q 14. There are value-oriented mutual funds that invest in indexes such as the S&P 500 Index and the Russell 1000 Index. Is this a more direct way to practice intrinsic value investing?

Q 15. How would an intrinsic value mutual fund or privately managed fund be recognized? [Table]

Q 16. Is there any other sign of genuine intrinsic value investing? [Table]

Q 17. Other than the number of names in the fund and the annual turnover of the fund, what else might indicate intrinsic value investing?

Q 18. My dilemma is that even though I earn a large income, after paying all the bills I never have anything left to invest. What can I do to accumulate some capital for investing?

 

FAQs and Answers

Q 1. Where do I get money to begin investing in the stock market?

A 1. There are four ways to acquire money to invest for your own account. One, by inheritance or gifts. Two, by marriage. Three, by windfall such a winning a lottery. Four, the old fashioned way, by saving out of your earnings from work (see The Richest Man in Babylon by Clason, cited in the Special Books, and The Millionaire Next Door by Stanley and Danko, cited in the General Books). Your first investments typically will be in human capital or health and education for marketable skills. Lifetime opportunities and income depend on the quantity and quality of human capital which will pay dividends throughout life. Financial capital is money that is not needed for living expenses and emergencies. In addition, once you have money to begin investing in stocks, you can borrow additional money through "margin" loans. But remember, margin increases leverage, and leverage increases both potential gains and potential losses.
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Q 2. Value investing and growth investing outperform one another over different historical periods and over periods of different lengths, from individual years to three, five, and ten years. Does this mean that an investor needs to first pick the approach that is expected to be best for the investment time horizon relevant to individual needs?

A 2. Intrinsic value investing is a philosophy characterized by a permanent commitment to the method of appraisal valuation only. That is one key to its success. Value investing outperforms in the long run, not necessarily in any short run period of performance evaluation. Thus, the philosophy does not become popular and thereby eliminate its competitive advantage.
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Q 3. I am an individual investor with my only stock holdings in a self-directed retirement account through my employer. How can I practice intrinsic value investing?

A 3. You can invest in publicly-traded open-end mutual funds (diversified investment companies) that have the investment objective of long-term capital appreciation subject to the preservation of capital and the investment method of value investing. Open-end funds are subject to the competitive peer pressures of quarterly reporting which forces them to focus more on the short-term than is desirable for value investing. You can also invest in closed-end funds which trade like common stocks. In addition, depending primarily on a test of your net worth, you may be qualified for invest in private hedge-type partnership funds that have the value investing objective and method.
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Q 4. Where do I get information about the investment objective and the investment method or style of particular mutual funds?

A 4. The prospectus of the mutual fund states its intentions and restrictions. The list of top securities held by the fund reveals its actual behavior. Identify the top holdings of the fund. A current prospectus can be acquired directly from the mutual fund management company, often by calling a toll-free telephone number. Other sources of mutual fund information include the Securities and Exchange Commission on-line service and Morningstar on-line service.
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Q 5. Although I do not know my IQ score, I know that I am not above average. I do not feel competent enough to appraise companies by the method of intrinsic valuation. How can I benefit from intrinsic value investing?

A 5. By delegating the selection of common stocks to buy, sell, and hold to a professional, full-time investment manager who practices intrinsic value investing in your behalf.
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Q 6. Should I pick stocks (choose investments), pick stock pickers (choose investment managers), or pick stock-picker pickers (choose a financial adviser)?

A 6. It depends on your interests and resources, but regardless of your level of personal involvement in the investment process, the responsibility for choice is inescapably yours.
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Q 7. I prefer to find a financial advisor who could identify and recommend investment managers who truly follow the intrinsic value appraisal method. Can you recommend someone in my geographical area?

A 7. As indicated on the Disclaimer page, we are not fiduciaries and thus we make no recommendations of specific professionals or commercial enterprises. It is useful to distinguish between investment advisors who help pick the stock pickers and investment managers who pick the stocks. You can usually find leads in the local telephone directory. The yellow pages sometimes include a public service advertisement offering a free booklet containing the questions you should ask any person before giving him or her your money to hold in a fiduciary capacity. The InvestorGuide web site (see the Selected Links) has several objective articles about finding , selecting, and taking advice from an advisor. Also the Investor Protection Trust web site (see the Selected Links) has information about checking out your financial professional. Without being misled by mere credentials, you might also inquire at professional organizations such as the Association of Investment Management and Research that sponsors the Chartered Financial Analysts program (1-800-247-8132, info@aimr.com). AIMR can provide the name and contact information for the CFA Membership Chairperson nearest you, who in turn can provide a list of CFA members and their affiliated organizations. This will help determine which advisors work for a fee and which work on a sales commission.
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Q 8. What difference does it make how a financial advisor is compensated?

A 8. Fee-based advisors have fewer inherent conflicts of interest with their clients than do commission-based advisors. One arrangement to minimize such conflicts is a periodic checkup on your financial health, say once a year. Get a review of your investments and financial planning documents by a fee-based financial advisor.
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Q 9. What is the CFA program?

A 9. An individual course of academic study that includes a broad range of content under the auspices of AIMR. The AIMR web site home page at http://www.aimr.com/aimr.html includes the options "CFA Program" and then "CFA Study Program" and then "Summary of the Body of Knowledge." Most relevant to Value Investing is "VI. Valuation and Investment Theory (Basic Investment Valuation Models)" and "VIII. Equity Investments (Fundamental Analysis)." The common stock models include discounted cash flow, P/E multiplier, alternative growth, and econometric cross-sectional regression. It is unknown whether a proper distinction is made between pricing and valuation. The CFA designation, like other credentials, is neither necessary nor sufficient for successful investment management as indicated by performance in the stock market. But do not expect a financial advisor or investment manager to prove with their Form 1040s that they earn more of their income from their own investing than from their management fees and other sources.
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Q 10. I have an IQ score in the top one percentile, but I do not wish to select my stocks. How can I find an investment manager with a high IQ who truly practices pure value investing?

A 10. Information about the IQ scores of investment managers is not publicly available. An investment manager who practices value investing will have a track record of selecting stocks on the basis of independent appraisal of individual companies and can provide the reasoning behind his selection of each stock. Pure value investing will not be augmented by market timing techniques even when applied to transactions to open and close positions.
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Q 11. I have an IQ score in the top one percentile, and I wish to select stocks, bonds and mutual funds based on my own research. Is there any advantage to selecting individual stocks and bonds as opposed to selecting stock mutual funds and bond mutual funds?

A 11. The small investor and the individual investor have several natural advantages relative to the large and institutional investors. Stated negatively from the point of view of the mutual funds, the major disadvantages are: (1) competitive pressures and quarterly reporting lead to excessive trading with its attendant transaction costs and capital gains taxes over which the individual investor in the fund has no control; (2) added costs including expense ratios and 12b-1 fees, and possibly sales loads if not a 100% no-load fund, over which the individual investor in the fund has no control; (3) large funds often must made large volume transactions that have significant deleterious market impact on the price of the stock or bond being bought or sold; (4) the fund may not be fully invested at all times even when this is desired but rather must always maintain cash reserves to meet redemptions by other investors in the fund over which the individual investor has no control; (5) the fund may be forced to sell some stocks in order to meet unexpectedly high rate of net redemptions over which the individual investor has no control; (6) a diversified fund, as defined by law, must invest in a minimum number of stocks in a minimum number of industries, and due to fund-specific fundamental and percentage restrictions, often greatly exceeds these minimum requirements as a hedge against ignorance, over which the individual investor has no control; and (7) the fund may not strictly adhere to either the investment philosophy or the investment objectives stated in its prospectus, over which the individual investor has no control.
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Q 12. What are some indications that a mutual fund is a true "Pure Intrinsic Value" fund? Is there an organization of mutual funds similar to the "100% No-Load Mutual Fund Council" to verify the representations made by member mutual funds in their prospectuses?

A 12. Unfortunately, there is no such organization known to exist. Each investor will have to closely scrutinize the prospectus of each mutual fund on his short list. Do not judge a mutual fund by its name. The presence of the word "value" in a fund name or fund family name does not necessarily imply the value investing investment objective and method let alone true intrinsic value investing. Your search can be reduced to more manageable size by screening out funds that are index funds, beta-criterion funds, industry-specific funds, sector-specific funds, size-based funds (example, small-cap, mid-cap, and large-cap), geographic area funds, and any other limitation not based on intrinsic value investing principles.
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Q 13. I screen stocks using economic "fundamental" criteria based on company-reported external accounting data such as net tangible assets per share. I thought that this was practicing value investing. It seems that I have not even begun to do the in-depth analysis required to determine whether a low relative price was also a low absolute price for no reasonable cause. This is discouraging because there is much tedious, arduous work involved in valuation as opposed to screening. Is there a service that provides the results of valuation analysis?

A 13. There are some information providers who claim to identify underpriced companies, but on close inspection, their stock selections probably will be found to be based on nothing more than relative stock screening without independent stock appraisal and or be based on a combination of value investing and market timing in some hybrid system. It is in the interest of practitioners of pure intrinsic value analysis to use their findings exclusively for the benefit of themselves and their investors. Such information is considered by them to be proprietary.
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Q 14. There are value-oriented mutual funds that invest in indexes such as the S&P 500 Index and the Russell 1000 Index. Is this a more direct way to practice intrinsic value investing?

A 14. The first part of your question concerns value investing and the second part concerns index investing. Lets consider them in reverse order.
First, a mutual fund that matches or mimics the S&P 500 Composite Stock Price Index may use the S&P500/BARRA Value Index and the S&P500/BARRA Growth Index to create two separate funds based book-to-market ratio with each fund containing common stocks representing half of the total market capitalization. Another mutual fund may use the Russell 1000 Value Style Index and the Russell 1000 Growth Style Index to create two separate funds based on the value weightings and growth weightings of each common stock with some companies appearing in both the value and growth funds. With any "value" fund of this type, the so-called value investing is in name only, being a mere mechanical screening of a universe of stocks with sorting and rank-ordering. There is no independent, critical judgment applied to appraise each company that has its common stock included in the index. Thus, this is not real value investing in the valuation sense of the term. For elaboration with examples, see the
styles criteria.
Second, index investing is by definition totally passive, not active management. While providing a floor against free falling stock prices, it also provides a ceiling against free flying stock prices, an opportunity cost that some investors overlook. By design, broad market indexes neither underperform nor outperform the market.
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Q 15. How would an intrinsic value mutual fund or privately managed fund be recognized?

A 15. An intrinsic value investment approach will avoid diversification for its own sake. The equity portfolio will not be concentrated in one industry or sector, as is a specialized fund by design. The appraiser will search for underpriced stocks in any lines of business within his circle of interest or competence. Sufficiently underpriced stocks are not easy to find. Thus, excessive diversification is a sign of ignorance about the pure, true, intrinsic economic value of stocks. One measure of the diversification of a fund is the ranking of the stocks in terms of their proportion of the total market capitalization of the equity portfolio. At the inception of the fund, one stock will represent 100% of the equity portfolio. Ultimately, a fund that has existed through at least one full bull-and-bear market cycle may approach the following composition.

  Number of Stocks Percentage of Fund
Mkt.Cap.Rank Total No. Cum No. Avg % Total % Cum % Cum.Avg %
1 5 5 6 30 30 6.0
2 5 10 5 25 55 5.5
3 5 15 4 20 75 5.0
4 5 20 3 15 90 4.5
5 5 25 2 10 100 4.0

Not many non-specialized publicly-traded mutual funds contain 25 or fewer stocks. Such concentration is more likely to be found in private hedge-type partnerships that are not required to report their quarterly performance in competition with other funds. TOP

Q 16. Is there any other sign of genuine intrinsic value investing?

A 16. An intrinsic value investment approach also will incur low turnover because the stocks are held for the long-term. Most publicly-traded mutual funds that are not index funds have annual turnover of the names in its equity portfolio in excess of 100 percent. At the other extreme, an inflexible buy-and-hold strategy results in a turnover of zero. The relation between average holding period measured in years and annual turnover is illustrated below.

Average

Holding Period

Annual

Turnover

0.5 year

200 %

1 year

100 %

2 year

50 %

5 year

20 %

10 year

10 %

As can be observed, relatively few actively-managed funds approach the lower limit of annual turnover of names in the portfolio. TOP

Q 17. Other than the number of names in the fund and the annual turnover of the fund, what else might indicate intrinsic value investing?

A 17. An intrinsic value investment approach also will tend to result in relatively low price multiples and ratios, both for the individual stocks and for the overall equity fund as a whole. They are relatively low in comparison with other stocks in the contemporary interest-rate and earnings-expectations economic environment. These are only rough approximations, but they sometimes have fairly high positive correlations with pure, true, intrinsic economic value. For example, low price/earnings, price/book value, price/cash flow, price/sales, and price/dividend (inverse of dividend yield) are common indicators of possible underpricing by the market.
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Q 18. My dilemma is that even though I earn a large income, after paying all the bills I never have anything left to invest. What can I do to accumulate some capital for investing?

A 18. Many people have high income and low net worth. Go to the
wealth formula to learn more about this dilemma and how to escape it. TOP


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