Global Value Investing
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.
This is a selective glossary for value investing terms only. For a more comprehensive financial glossary, see the most popular textbooks for investments. These definitions are included for certain terms that appear at this website. Following this is a list of other keywords for use in web-wide searches.
accounting value : one of three concepts of stock value, accounting value is measured by company-reported external accounting figures such as book value per share or net worth per share; see value.
Allais paradox : A simple illustration of Maurice Allais' general theory of random choice. Just as the St. Petersburg Paradox led Daniel Bernoulli to replace the principle of maximization of the mathematical expectation of monetary values by the Bernoullian principle of maximization of cardinal utilities, the Allais paradox leads to adding to the Bernoullian formulation a specific term characterizing the propensity to risk which takes account of the distribution as a whole of cardinal utility and not merely the average of the distribution. See the entry for Petersburg paradox.
appraised value : the economic value of a company both as a continuing going concern and as a resource converter. Includes consideration of net asset value, breakup value, liquidation value, and replacement cost.
arbitrage : buying stuff or paper claims on stuff in one market and simultaneously selling them at a profit in another or at another time. Price arbitrage includes several possibilities. One is similar assets, such as two companies in the same line of business. A second is the same asset now and in the future, such as a common stock and put or call options on that stock. A third is whole packages of assets and their disaggregated individual parts, such as a conglomerate and its subsidiaries. A fourth is stuff and paper, such as direct private ownership and indirect publicly-traded shares. Risk arbitrage focuses on of whether or not an announced merger or acquisition will actually be consummated in a timely manner independent of market prices.
beta : a creation of academic captal asset pricing theory; an artifact of statistical linear univariate regression analysis which suffers from three fallacies: first, there is a single, linear, general, quantitative measure of so-called investment risk; second, reification or there is a real entity measured by beta; and third, confounding within-group variation and between-group variation. The same fallacies occur in the measure of intelligence. In addition, estimated beta is not robust and not always stable because it is calculated from an arbitrary choice of time periods (1 month, 3 months, 12 months, 30 months, 60 months, etc.) and market proxies (S&P 500 with dividends, S&P 500 without dividends, Wilshire 5000, an equal weighted index, a market capitalization weighted index, a global equity index, etc.). The market proxy is a measure of all the investment assets in the world including both financial and intellectual capital. The book entitled The Mismeasure of Man by Stephen Jay Gould (see citation in General Books) could be retitled The Mismeasure of Investments with Markowitz's beta substituted for Spearman's g. Harry Markowitz, author of Portfolio Selection: Efficient Diversification of Investments, 1959, New York, NY: John Wiley, is regarded as the founder of modern portfolio theory.
Three interpretations of beta:
(1) Econometrically, beta is the primary risk factor and artifact of the univariate Capital Asset Pricing Model (CAPM) which may be useful for theoretical studies of the pricing process but is irrelevant to valuation of companies. In the real world, price is not value. The beta statistic is estimated by the CAPM from an arbitrarily chosen set of historical data and .
(2) Graphically, beta is the slope coefficient of the characteristic line with the stock's rate of return on the y-axis and the rate of return on a market portfolio on the x-axis. The straight line is fitted to the market data using ordinary least squares (OLS) regression which assumes that the variables follow a Gaussian (normal) distribution. Empirical studies consistently show that stock prices and thus returns follow a Stable Law distribution which is mathematically intractable.
(3) Statistically, beta is the measure of systematic risk in the CAPM and is the ratio of two covariances: the individual security divided by a proxy for the market as a whole or the so-called market portfolio. The beta factor is the expected change in the security's rate of return divided by the accompanying change in the rate of return to the market portfolio. Market correlation is a concept that applies to financial asset pricing but not to valuation. The correlation coefficient is a statistic that scales the covariance to a value between minus one (perfect negative correlation) and plus one (perfect positive correlation). Covariance is a measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns move together. A negative covariance means they vary inversely.
Irving Fisher, on the faculty at the University of Chicago Graduate School of Business at the time, is reported to have disapproved allowing Markowitz to become a Ph.D. candidate there because his dissertation topic was portfolio theory which was mathematics (statistics) and not economics.
bargain issues : share price below realizable assets or net working capital per share defined as net current assets alone, excluding plant and equipment and other assets, and after deducting all liabilities ahead of the stock in liquidation.
breakup value : the amount of money that could be realized when a company is broken up into individual parts and marketed separately. Certain companies at critical times are worth more dead than alive. The ultimate breakup of a going concern is liquidation, sometimes in bankruptcy proceedings, and some investors seek out these special situations. The breakup value represents a floor on the value of the company to the extent that if the market price of the common stock falls below the breakup value of the company, the company becomes attractive as a takeover target.
capital preservation : maintaining the real value or purchasing power of the capital in an investment portfolio or account
contrarian : a style of investment characterized by acting opposite to the crowd, and therefore not independent critical thinking but rather negative groupthink.
DCF Model : see dividend discount model; the conceptual model originated by John Burr Williams for the appraisal of the pure, true, intrinsic economic value of companies and their common stock. It is pure because there are no accretions such as beta or market timing. It is true because it is based on economic value rather than so-called accounting value (book value) or market value (market capitalization of equity or share price times number of shares outstanding). There are many empirical versions of the DCF Model, each designed to simplify the data requirements. The DCF Model could be called the Capital Asset Valuation Model (CAVM) to emphasize its radical difference from the Capital Asset Pricing Model (CAPM).
discounted cash flow (DCF) : a class of appraisal models based on discounting at an appropriate interest rate the net cash flows attributable to an investment opportunity; the best known DCF model is the so-called dividend discount model
discount rate : the investor-specific reward for abstinence or patience or delaying consumption sought by the investor. At a minimum, the lowest risk (a.k.a. riskless or risk-free) rate of return on an alternative investment available to the investor with a time horizon comparable to that of the investor. The investor's time horizon is the duration from the present time of potential purchase of the investment to the planned future time of realization by selling the investment. This rate reflects the economic opportunity cost of the investor and is usually the yield on a national government security. For example, for an investor in the U.S. the discount rate could be the yield on a U.S. Government bond with an appropriate term to maturity. The longest term for a U.S. government bond is 30 years.
dividend discount model (DDM) : see the DCF Model; the intrinsic economic value appraisal model originated by John Burr Williams in his application of Irving Fisher's theory of interest (see citations for both authors in the Special and General Books, respectively); a more descriptive name is "cash distributions discount model" because this model includes either dividends in perpetuity, or equivalently, distributions from not only dividends but also future selling price as estimated by either book value/price, price/earnings, or dividend/price ratio; in his application of this model, Williams avoided the theoretical problem known as the Petersburg Paradox (see citation for Durand in the General Books).
economic value : one of three concepts of stock value; includes intrinsic value and appraised value; see intrinsic value, appraised value, and value.
efficiency, market : an efficient capital market is efficient in processing information. The prices of securities observed at any time are based on "correct" evaluation of all information available at that time. In an efficient market, prices "fully reflect" available information.
fad, financial : a manifestation of market irrationality, often a contagion.
fallacy : cognitive errors including cognitive dissonance. See Stephen Downe's Guide to the Logical Fallacies online [Go to Guide].
feedback trading : a form of market timing that uses technical analysis or charts and that attempts to predict future prices from the time sequence of past prices.
forecast : an estimate based on a projection of historical data into the future; contrasted with a prediction which is an estimate based on understanding the causal relationships among the key variables in a system.
free cash flow to equity : free cash flow for the common stock equity account or the cash available for distribution to the ultimate equity owners; a measure of the ability to generate discretionary cash flow; an accounting concept that is equal to net income plus non-cash charges (depreciation, depletion and amortization) minus debt and other fixed obligations net of tax savings on interest expense minus preferred dividends minus fixed capital expenditures needed to maintain the company's economic productive capacity at the same level minus the increase in working capital needed to maintain the company's economic productive capacity at the same level. Such adjustments for working capital are not generally required except in usual situations.
fundamental analysis : a method of appraising operating companies that uses data in external accounting reports to stockholders, such as those filed by U.S. companies with the U.S. Securities and Exchange Commission, rather than market-generated data.
generally accepted accounting principles : GAAP.
growth investing : an ambiguous term that generally refers to the use of fundamental analysis with an emphasis on growth in earnings and that relies on forecasts of earnings growth rates rather than appraisal of value. Some growth creates economic value, but some growth does not. Any company in any industry can buy growth. In the short run this may benefit the company's customers, but in the long run it is unlikely to benefit the company's stockholders. It is often contrasted with value investing as a style, but not with value investing as an approach. The two styles are like Siamese twins joined at the hip.
guru : a management expert is referred to as such because journalists cannot spell the word charlatan (attributed to Peter Drucker), and this can be extended to include stock market wizards and any other self-described experts on investing.
intelligence : some people are hostile to the concept of intelligence. We here refer to the general factor of intelligence or Spearmans g measured by so-called IQ tests and discussed in The Bell Curve by Herrnstein and Murray (see the citation in the General Books).
intrinsic value : the economic value of a company or its common stock based on internally-generated cash returns; the primary objective in using the adjective "intrinsic" is to emphasize the distinction between value and current market price. It is a concept which is difficult to operationalize in a mechanical fashion. Any investment is worth what you can get out of it. Intrinsic value can be thought of as the discounted stream of net cash flows attributable to an investment asset, and these cash flows for common stocks are periodic dividends or free cash flows to common stock equity owners and the terminal price or liquidating dividend. The practical limitations are selecting an appropriate discount rate and estimating the future cash flows. The concept can be helpful without a corresponding formula to reduce it to computational simplicity. Intrinsic economic value is the private appraisal independent of the current market price of an operating enterprise. This independent value has a variety of names, the most familiar of which is "intrinsic value." It may also be called "investment value" [see entry below], "indicated value", "central value", "normal value", "reasonable value", "fair value" (in some legal proceedings), and "appraised value" [see entry above].
investment management : also known as capital management and money management: whereby investors delegate their investment decision-making authority but not their personal responsibility for outcomes.
investment objective : the goal toward which the investor aims including not only economic but also social, political, religious, national, and other ends.
investment style : the method used to achieve a given investment objective including asset allocation, stock selection, transaction order handling, and other means. A distinction can be made between intended style and historical style. Styles can be changed like fashions. Styles can be mixed or hybrid. Style is a misnomer when applied to value investing which is not a fashion and is not mixed with other approaches to form a hybrid but rather is a pure long term permanent commitment to the method of valuation only.
investment value : a term used to designate the estimated worth of an investment opportunity that is equal to the intrinsic value bracketed by the replacement value ceiling and the liquidation value floor.
liquidation value : a balance sheet concept that represents the amount of money that could be realized by breaking up the company, selling its assets, repaying its debt, and distributing the remainder to its stockowners. [see breakup value]
long-term : from the perspective of the value investing approach, a long-term horizon is measured in terms of years, not in terms of hours, days, weeks, or months.
margin of safety : the difference between price and value for a common stock.
market timing : any attempt to use past prices and other market-generated data to accurately forecast or prophesy future prices of securities or indexes, whether long-term or intra-day, consistently and persistently. Includes asset allocation, technical analysis, charting, momentum investing, and quantitative analysis using neural networks, genetic algorithms, artificial intelligence (AI), fuzzy logic, chaos theory or other non-linear techniques. As the offering circulars are required to disclose: "Past results are no guarantee of future performance."
Graham and Dodd, Security Analysis: The Classic 1934 Edition. Chapter LII Market Analysis and Security Analysis, pp. 607-16: "Forecasting security prices is not properly a part of security analysis. ... Most emphasis is laid in Wall Street upon the science, or art, or pastime, of prophesying the immediate action of the "general market," which is fairly represented by the various averages used in the financial press. ... There is no generally known method of chart reading which has been continuously successful for a long period of time. If it were known, it would be speedily adopted by numberless traders. This very following would bring its usefulness to an end."
market value : one of three concepts of stock value, also known as market equity and as market capitalization; market value is measured by market-generated figures and is equal to the number of shares of common stock outstanding multiplied times the market price per share; alternatively, the number of shares outstanding not held in private is used in the calculation; see value.
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