Questions on the Readings (Lesson 1, Deep Value)


Contrariwise, if it was so, it might be; and if it were so, it would be; but as it isn’t, it ain’t. That’s logic.
~ Lewis Carroll

When dealing with people, remember you are not dealing with creatures of logic, but creatures of emotion.
~ Dale Carnegie

Mastering others is strength. Mastering yourself is true power.
~ Lao Tzu

Your goal should be to find an investment approach that works for you.  You will need to determine your investment edge.

You should read:

the Preface from Deep Value (Toby Carlisle)

Chapter 20_Margin of Safety Concept

Buffett Klarman and Graham on Mr Market

Behavioral Portfolio Management

Questions from the readings:

  • Do you agree that deep value investing is an investment triumph disguised as business disaster?
  • What do you see as the biggest investment risk(s) in “deep value investing?”
  • When do stocks appear most attractive and when is the risk highest?
  • What is considered the main margin of safety metric?
  • What are investors rewarded for?
  • What concept must you truly grasp to be a successful deep value investor?
  • Why do prices move more than intrinsic value?
  • True or False: A good value investor understands and takes advantage of the behavioral biases of others because he has already eliminated them in him/herself?
  • Deep value investing often means buying distressed assets but can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices? Name two investments by Buffett that might fit that criteria? WMT_50 Year SRC Chart
  • How can we think of activist investing?
  • What are your goals for this course?
  • How do Mr. Graham and Mr. Buffett view buying a share of stock?
  •  What do you do if you can’t find an attractive investment?
  • What is Mr. Market’s purpose?
  • How are prices set? in Philadelphia it’s worth fifty Bucks (video)
  • Are prices based on subjective or objective valuation?
  • If you are playing poker and you don’t know who the sucker is—why is that a problem?  Who’s the sucker? Playing the sucker  (video) What EMOTIONAL error did the SUCKER display? When did the sucker CEASE to be a sucker?   What is the main error–man, especially male, beginning investors—exhibit?
  • What is the key to investment success?
  • What TYPE of market participant seeks Mr. Market for investment guidance?  Do you notice any conflicts, ironies or problems?   Or can it be a way to improve your investment results?
  • How do many investors react to huge market volatility?
  • Did Mr. Graham give you a way to access the valuation of a common stock? Explain.
  • Extra credit: Did Graham ever give a FORMULA for determining intrinsic value?  Be careful and read the footnotes to the formula he presents and why he offers it to readers. See Intelligent Investor.
  • What is the biggest mistake investors make when buying securities? How would you prevent that? What does Graham do?
  • What is the danger in growth stock investing?
  • What is a good or bad stock/investment?
  • When during the past fifty years were the greatest American companies (Franchises mostly) bad investments. Why?
  •  What is the best approach to take in investing.
  •  What is risk?
  • Why do so many “smart” people fail at investing or at least do less well than simple stock indexes over time?

You can email me at Aldridge56@aol.com with LESSON 1 in the title with questions and answers or post here in the comments section. If you don’t have time or wish to pass then come back to this lesson later.

  • What are the five investment criteria in the Behavioral Portfolio Management? 
  • What is the cult of emotion?
  • Is it possible for emotion to help you as an investor?

I will be asking for one or two volunteers who wish to research the article BEHAVIORAL PORTFOLIO MANAGEMENT.   You will need to read the articles below and then determine if the author’s five criteria will work.   Over this course, I will probably assign twenty or so special projects. Then we will share your work/efforts.

SSRN_Behavioral Measures of Expected Market Return

SSRN The Importance of Investment Strategy_Howard

SSRN Behavioral Portfolio Management_Thomas

Taking-the-emotion-out-of-investing

Making Money Out of Emotions   How investors fail because of their own brain.  Solution: Pre-program your portfolio.

I will post the review of the lesson/readings by the end of the week. There will be supplementary material posted throughout the week.   You will also be emailed any postings.

31 responses to “Questions on the Readings (Lesson 1, Deep Value)

  1. I’ll answer a question.

    “can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices?”

    The WMT chart says is telling us “basically no”, although it was really cheap at the end of 1974. The stock has been undervalued, and sometimes fairly valued, then through the rest of the 70’s. If you had bought at slight levels of overvaluation, then you probably would have done very well. Note that in the late 90’s the stock was very overvalued, causing the stock to go sideways until 2011, at least.

    Looking at the figures on Google today, WMT has grown EPS by 5% annually over the last 3 years, and trades on a PE of 17.94.

    The chart also shows a few other interesting features: the chart is shown on a logarithmic scale, and earnings and dividends are flattening out, and the gap between dividends and earnings is narrowling. It is speaking volumes! In its initial phase it was a high growth company with a low payout ratio. By 2011, growth had moderated, and the payout ratio had increased.

    As of today, the PE looks a bit stretched, and maybe you could earn a 7% return (I’m taking the 5% growth and adding on the yield of 2 and a bit percent) – although you will probably have to sweat of some of that excess valuation.

    I would expect a “deep value” investor to be able to do better than that (assuming he doesn’t do worse, of course).

  2. Some very interesting an thought provoking questions. I’m currently going through them.
    I’ll be honest and say I can’t judge if and when Walmart was a good buy by the graph.
    Here is an interesting piece on the value of Walmart in 1974, knowing what we do now it was a huge buy. 🙂 http://www.philosophicaleconomics.com/2014/03/wmt/

  3. I also wanted to make a few comments on the material we read (which I enjoyed going through).

    Regarding Mr Market, Buffett is quoted as saying
    “Sometimes, of course, the market may judge a business to be more valuable than the underlying facts would indicate it is. In such a case, we will sell our holdings.”

    I think it is important to note this is much harder to do and judge in reality. Buffett may have failed to follow his own advice at end of the 90s when he failed to sell his holdings in Coke etc. He was open enough to admit his ‘big mistake’ and may have regretted in decision to act.

    http://brooklyninvestor.blogspot.se/2014/03/buffett-market-timer-part-4-berkshire.html
    See comments for 2003

    Mr Market, I believe, is a useful mental model to prevent value investors from reacting to and being influenced by pure price movements only (although lets not forget that momentum investing, buying winners, has been shown to give above index returns).

    I find it difficult to agree with Klarman’s statement
    “The reality is that Mr. Market knows nothing, being the product of the collective action of thousands of buyers and sellers who themselves are not always motivated by investment fundamentals.”

    To say Mr Market knows nothing is to greatly underestimate market efficiencies. In fact I would say Mr market is actually very good at pricing securities, ok he’s not perfect, and mistakes are made, especially in hindsight, but the unfortunate reality is beating simple indices is achieved only by a very, very small proportion of investors. Mispricings by Mr Market, which can be capitalised upon, are surely few and far between.

    With market cap indices, stocks are not only being purchased at Mr Markets prices but also more of the ones he is shouting about the loudest! Consistently following such a strategy can actually be very rewarding for ‘passive’ investors.

  4. “Deep value investing often means buying distressed assets but can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices? Name two investments by Buffett that might fit that criteria”

    Washington Post and GEICO, but I imagine such scenarios are very hard to come by as mcturra2000 mentioned above. It could happen in those once every 10-20 year crisis like some during the last crisis.

  5. “Do you agree that deep value investing is an investment triumph disguised as business disaster?”

    My take on this is: Yes if you can control your emotions and stick to your strategy when it doesn’t work.

    Because deep value companies will often look ugly, hated and ignored so the general investor perception will be negative. This will create opportunities for price and value disparities.

    Secondly, research shows that low P/B and net-net strategies outperform corresponding benchmarks by a significant percentage e.g. benjamin-grahams-net-nets-seventy-five-years-old-and-outperforming by Tobias Carlisle, shows the NCAV portfolio, comprised of stocks with less than 2/3 of NCAV, outperforms small cap portfolios by 16.9 % per year between 1983 -2008 with mean monthly returns of 2.55 %.

  6. I’d like to made a few follow-up observations.

    Wasn’t 1974 the year when Buffett bought Washington Post? That being so, I don’t think Buffett’s point is particularly strong. 1974 was a recession year, and, as we’ve seen, Walmart was a bargain, too. Guess what? When the market tanks, everything you buy will subsequently make money. I personally bought some BATS (Brit Amer Tobacco) in 2008/9, and was astonished to see that a few years later they had doubled in value (whereupon I sold). You don’t normally associate defensives as being 2-baggers within a 3-4 year timeframe, but it can happen, IF you buy after a financial meltdown.

    That’s a big IF, though. Is it really wise to wait 10-20 years for a crisis to come along? How would you know when the crisis is “deep enough”?

    I think Buffett’s purchases of GEICO and American Express are more impressive. The pruchases were made at a time of real uncertainty in the companies.

    Anoter thought: we of course all know that WMT would have been a great purchase in hindsight, but would we have known in the 70’s what a success WMT would be?

    I also think it’s worth pointing out that each decade has it’s own peculiarites. The 70’s seemed a difficult period for the market. The 80’s and 90’s was a phenomenal bull market. The 00’s had all sorts of things going on: tech crunch leading to a glut in value, a credit crunch in 2008, followed by a sharp recovery.

  7. You both bring up excellent points. WMT could redeploy capital at high marginal returns on invested capital for a long period of time because of its regional economies of scale–yes, easy to see in hindsight. Use search box on csinvesting to read further discussions on wal-mart.) Perhaps that is the point–even Buffett missed by not investing. Franchise investing takes tremendous business knowledge. Not easy. 1974 was extreme during a period of out of control (10 pct. inflation and rising interest rates). A “Graham and Dodd” investor who spends time looking at past historical cycles is Arnold Van Den Berg over at http://www.centman.com.

    Klarman keeps a large reserve of cash while waiting for financial catastrophes while Greenwald would say just defer to an index since 70% of the time the market goes up. I think you need to think through what YOU can comfortably adhere to because of your understanding of the trade-offs.

    • John, Howard Marks made a great response to the whole cash reserve issue: whilst cash reserves may give you optionality, it may also incur opportunity cost.

      So I do tend to side with Greenwald on this (which is actually a rare occurrence for me).I’ve always felt that the optionality argument to be too generalised.

      Lynch tried to stay 100% invested, and switch investments if he thought he found something that was at least 50% better. That makes a lot of sense to me.

      Perhaps one could add the proviso that you could liquidate when you thought your companies were at fair value, and only re-invest when there was an adequate margin of safety.

      So, rather than have a “policy” about cash levels, I think it’s better to have cash levels which are directed by availablity of suitable investors.

  8. How can we think of activist investing?

    We can think of activist investing as attempting to narrow the gap between a security’s market price and its intrinsic value. One aim is to to bring awareness and attention to shareholders of their true position as OWNERS within the corporate structure, and to act as a check on management regarding oversight, mismanagement, or other misplaced strategic decision-making that fails to return value to shareholders.

    Why do so many “smart” people fail at investing or at least do less well than simple stock indexes over time?

    Misplaced confidence, failing to identify the ‘unknowns’ in their assessment of a situation, myopic thinking, and overpaying for growth and other optimistic signals that the market has likely already priced in to a security’s price. Essentially being unwilling to walk away from the crowd and analyze companies that the market shuns, and then failing to analyze companies within that subset that don’t display the traditional traits typically associated with an attractive security. Looking too hard at wonderful companies at good prices, rather than good companies at wonderful prices. To me, that’s deep value.

  9. Professional investors not being able to consistently beat indices, despite the number of strategies that are reported to do so, for me is one of the greatest oddities in finance.

    Perhaps this goes some way to explain it. They sell undervalued stocks.

    http://www.alphaarchitect.com/blog/2014/12/29/pro-investors-contribute-to-stock-anomalies/#.VKqz3stwbqA

  10. adding some info on Berkshire’s purchase of WMT.
    Walmart from Berkshire Hathaway shareholder letter
    year shares cost cost per share average P/E relative P/E
    2004 not shown 22.8 1.2
    2005 19944300 944 $47.33 18.3 0.97
    2006 19944300 942 $47.23 16 0.86
    2007 19944300 942 $47.23 14.9 0.79
    2008 19944300 942 $47.23 16.2 0.97
    2009 39037142 1893 $48.49 13.9 0.93
    addition in 2009
    2009 19092842 951 $49.81 13.9 0.93
    2010 39037142 1893 $48.49 13.1 0.83
    2011 39037142 1893 $48.49 12.4 0.78
    2012 54823433 2837 $51.75 13.5 0.86
    addition in 2012
    2012 15786291 944 $59.80 13.5 0.86
    2013 56805984 2976 $52.39 14.9 0.84
    addition in 2013
    2013 1982551 139 $70.11 14.9 0.84
    Prior to 2004, WMT’s average P/E and relative P/E was much greater than 22.8X and 1.2 (P/E and relative P/E from Value Line)

    Perhaps we should buy quality at a fair price until there is another crisis for deep value investing. At that time, I am not sure I will have the resource or gut to do so.

  11. • Do you agree that deep value investing is an investment triumph disguised as business disaster?
    No, deep value is only an approach to participate from the greatest fear in the market and the possible distress of a company.

    • What do you see as the biggest investment risk(s) in “deep value investing?”
    Value investing at its core is to have an understanding of the underlying value of the asset/company, the use of an appropriate discount rate and margin of safety which is a fail save for you analysis. Therefor you should normally have a positive risk/return. As deep value is mainly a mechanical investing strategy, the biggest risk for me lies in the honesty of the Management.

    • When do stocks appear most attractive and when is the risk highest?
    Normally stocks appear to be most attractive at the top of an earnings cycle but this is actually the time where the risk is the greatest.

    • What is considered the main margin of safety metric?
    That you have an appropriate difference (30-50%) between your calculated fair value (N-EPV) and the current stock price after you have used an appropriate discount rate.

    • What are investors rewarded for?
    According to the CAPM Investors are rewarded for the risk they take, but in my opinion they are rewarded for their contrary opinion. They step into the market where other investors are fearful and don’t act rational.

    • What concept must you truly grasp to be a successful deep value investor?
    You have to master the math and learn to trust it. If you trust your methods you can be calm when others aren’t. Furthermore you have to master the basics of psychology to understand human misjudgment and anchoring effects.

    • Why do prices move more than intrinsic value?
    Because people are greedy and fearful and don’t act rational all the time

    • True or False: A good value investor understands and takes advantage of the behavioral biases of others because he has already eliminated them in him/herself?

    Yes and No: A value investor should be aware of behavioral biases and should try to eliminate them but in reality he probably will never eliminated them all.

    • Deep value investing often means buying distressed assets but can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices? Name two investments by Buffett that might fit that criteria? WMT_50 Year SRC Chart
    Sometimes if you are well prepared you can buy franchises for a deep value price, but this situations are very rear. American Express and Wells Fargo

    • How can we think of activist investing?
    In my opinion activist investing itself is only a catalyst to narrow a discount to its fair value which is a good approach, but most of the time quiet short term oriented.

    • What are your goals for this course?
    To solve some of my behavioral biases and learn to become a better investor.

    • How do Mr. Graham and Mr. Buffett view buying a share of stock?
    Mr. Graham tries to buy Net-Net’s and Buffett tries to buy wonderful companies.

    • What do you do if you can’t find an attractive investment?
    As always the opportunity cost of capital are your second best idea, the last idea would be treasury notes.

    • What is Mr. Market’s purpose?
    To match supply and demand

    • How are prices set? in Philadelphia it’s worth fifty Bucks (video)
    Supply and demand

    • Are prices based on subjective or objective valuation?
    Prices are set on an subjective valuation

    • If you are playing poker and you don’t know who the sucker is—why is that a problem? Who’s the sucker? Playing the sucker (video) What EMOTIONAL error did the SUCKER display? When did the sucker CEASE to be a sucker? What is the main error–man, especially male, beginning investors—exhibit?
    Because you have no edge. Most probably you. Suckers and males in investing are most of the time overconfident, which lead to mistakes and a bunch of lost money.

    • What is the key to investment success?
    Honesty about the thinks your know and thinks you don’t know. Stick to your circle of competence and try to broaden it step by step. And pay a low price

    • What TYPE of market participant seeks Mr. Market for investment guidance? Do you notice any conflicts, ironies or problems? Or can it be a way to improve your investment results?
    Gamblers are attracted to it. If many gamblers are in the room it creates the space for bubbles and busts. If you are aware of this you can try to beat the market and most probably will.

    • How do many investors react to huge market volatility?
    According to the CAPM, volatility is seen as risk therefor most investors try to avoid it and react with panic. For a value investor volatility is a friend because it brings opportunities.

    • What is the danger in growth stock investing?
    That you overpay for the potential growth and that you overestimate the growth

    • What is risk?
    The risk lies in yourself, if you overestimate your abilities and the ones of your model

    • Why do so many “smart” people fail at investing or at least do less well than simple stock indexes over time?
    Because they are overconfident and short-term orientated. Furthermore many “smart” fund manager have an understandable aversion to lose their job. Therefor they try do what everyone else to. (It’s better to be wrong one anyone else is)

    To be continued

  12. Deep value investing often means buying distressed assets but can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices? Name two investments by Buffett that might fit that criteria?

    The two companies jump into my mind are GEICO and Coca Cola.

    I think Mr. Market is there to provide quantitative information for investors sort of like market makera at the trading pit. Investors don’t have the act on the information provided by Mr. Market.

    The danger of growth stock investing is that investors overpay for growth that may not materialize in the future.

  13. Was Coke a deep value stock at Buffett’s purchase? I thought i read somewhere its PE was around 15 at the time. I might be wrong though.

  14. Value Investing is not a game where the IQ160 guy beats the IQ140 guy. It does require a brain, but most of all it requires patience and discipline. Patience to wait for the fat pitch and not swing at the “easy money” that everyone else is making, and discipline to demand a margin of safety in every investment made. Value Investing is not a methodology. It is a mindset. And it can be applied to every industry and asset class.

    Thanks for the great blog. I enjoy reading it.

  15. Excellent reading and course materials thus far … some comments on risk:

    What Is Risk?
    Risk should be measured by the probability of permanent loss of capital. Emotional/uneconomic selling during a downturn due to lack of conviction in your investments is a sure way to lock in a permanent loss.

    What do you see as the biggest investment risk(s) in “deep value investing?”
    Deep value stocks tend to have a higher statistical rate of failure (bankruptcy). It so happens that the upside over the long-term tends to compensate for these risks. Cherry picking your situations incorrectly could lead to a lower rate-of-return than simply sticking with 10-20 statistically cheap issues over the long-term and rebalancing occasionally. Tobias Carlisle discusses this in-depth during his talk at Google.

    • Interesting comments. I think he has a ‘quant’ model that has been shown to work in back testing and wants to remove his emotions and biases that will degrade its returns going forward.

      You comment “Secondly, his focus on distressed or heavily indebted businesses is worrisome. ” perhaps captures why it works. 🙂

      Other market participant are looking at the same numbers and thinking the same things ‘I don’t want to touch this’. The results is an undervaluation of the business. i.e. it’s bad but not that bad!

  16. I still have to do a lot of reading but wanted to comment on P/E and Value Investing. As I was reading I began to think of Avon, Sears, and Radio Shack. I consider myself a value investor, but hesitate at low P/E and always question whether it’s a value or a value trap. Looking forward to this class and catching up to the rest of you already deep into the readings.

  17. I’ve been reading the Intelligent Investor (through chapter 11), so I took this course to reinforce and validate my reading. I’m already a strong believer in value investing, margin of safety, and the foibles of Mr. Market. I know for myself my goal for this course is to be a successful value investing practitioner, more than simply an investing theorist.

    Firstly, I think there are a few naive questions in this discussion.

    “What is the key to investment success?”
    “What is a good or bad stock/investment?”
    “What is the best approach to take in investing.”

    I really hope these are purposefully rhetoric questions, because firstly, if we knew the answers to these definitively, everyone would follow a rote formula of the “best” way to make money. Speaking in absolutes is always a fool’s errand. Therefore, by not knowing the One True way to investing success, we can’t really say what the keys are to investing success, as everyone has different ideas.

    Greenblatt is huge on ROIC and EBIT/EV. Phil Town is all about EPS + Sales + Equity + Cash Flow. Piotroski has his own score card. Graham and Klarman were all about NCAV (this sort of answers your question about Graham’s formula – I mean he does have one, otherwise people wouldn’t be making stock screeners about it. Either way, NCAV was more so Graham in the post-Depression era) and discounted intrinsic value (margin of safety). All valuable metrics, but all different, and each would defend why his metric was the key to his success.

    …and because of the above, they will all defend why their stock was a good investment at the time, while the others would argue why it is a bad investment. Which I guess drives your point home about us all have inherent psychological biases, and how Mr. Market is the manifestation of that irrationality in securities pricing. Everyone has an idea of why he should enter/exit a security, and will have some way of rationalizing it. Plenty of stocks have tanked even when the numbers have looked promising (tech stocks in 98-99 going into 2000) while plenty of overpriced securities continue to perform (see most large caps in 2013-2014).

    What I’d really like to discuss is the Next Paradigm article, which i think is the most controversial article you presented. I think it is wildly iconoclast to the rest of the value investing sermon, but first, the connections.

    The strengths (and similarities to value investing) that Behavior Portfolio Management presents is that it tames Mr. Market. It is about controlling the chaotic variable that is your irrationality to act on a security based on the irrational market movements of Mr. Market. It gets you to remove the personality from a business by making it nameless, thus focusing on the business solely by it’s numbers. This passionately impersonal and mathematical approach appears to have yielded great results (though I am skeptical of his backtests, I would like to see a third party verify that this approach was truly that positive). Worrying about things like Dividend Yield and Dividend Payout Rate are positive indicators that these portfolio managers do care about the overall strength of the companies they invest in – if you’re a buy and hold investor, you want to own great companies, and this is what we can agree on is sound practice. Graham defends this in Chapter 11 and states that these two specifically along with moat are definitive ways to judge whether a security is worth purchasing.

    The weaknesses are actually the same thing. This lack of personality to their investments misses key metrics to business evaluation. Without a brand, you don’t know the management. Without knowing the management, you can’t know if the captain will steer the ship in the right direction, after all businesses are run by PEOPLE, not algorithms. In chapter 11 of the Intelligent Investor, where I am at right now, Graham (and the comments) specifically addresses that Management is also one of the five things to consider, and we completely skip that in the Behavioral approach. As an aside, this truly sounds like algorithmic trading, not active portfolio management. If you rely solely on a heuristic, that is, by definition, algorithmic trading, and I can’t see how you can argue it any other way. Secondly, his focus on distressed or heavily indebted businesses is worrisome. In the comments of Chapter 11, we learn about one of Graham’s five ways of evaluating worthy companies is strong “long-term prospects” of a company means avoiding OPM addicts, or those heavily leveraged on Other People’s Money. The Behavioral argument would suggest that lots of leverage means that outsiders are willing to pump lots of cash because they really believe that the company is going to succeed. But as we read in the comments of the Intelligent Investor, “they can make a sick company appear to be growing even if its underlying businesses are not generating enough cash.”

    To conclude, this was a great thinking intro exercise to value investing (particularly in the Next Paradigm), but if you’re not a complete beginner, this may have been old news.

  18. If I am not wrong, Greenberg said that if someone is able to value correctly a business should be able to make money in the stock market. I agree since if you value a business correctly, be it a franchise or not, then margin of safety becomes a subjective issue depending on confidence, unknowns, experience, etc. and the investor should take advantage of price when it is available at the desired level. Templeton kept a list of companies that would be bought automatically if they reached a price so that his rational decision was made far away of the ” emotional time”.
    I guess that in some way my short commentary answers most questions and my opinion is that if we try to keep away emotional decision we should keep the process very simple.
    I am in the course to challenge constantly my knowledge and experience and find new ways to be “different”. Thank you

  19. I’ll try to answer these 4 questions having Tesco PLC in mind as an example:
    ■Do you agree that deep value investing is an investment triumph disguised as business disaster?
    ■What do you see as the biggest investment risk(s) in “deep value investing?”
    ■When do stocks appear most attractive and when is the risk highest?
    ■What is considered the main margin of safety metric?

    The contrarian nature of deep value investing can make me feel alone in arguing in favor of Tesco as a long-term investment. After all, the business is currently a disaster, with a new external CEO trying to turn the giant ship around. Every piece of news for the company is bad. In particular, the profit warnings never seem to end.

    The risk that I see (and actually experienced because I am already invested) is the price will go down further from my initial purchase price. I expect that from the sometimes irrational behavior of other investors.

    However, I believe that in Tesco’s case, the more it falls or stays at the current level, the more attractive it becomes. After all, it is still a dominant player in the UK market. A decline from 31% market share in 2006 to 29% today is no big deal. it can use its real estate scale to capture more market share in online shopping. In addition, it can realize the value of it real estate as well as its international holdings.

    One margin of safety comes from the value of its real estate, estimated to be twice its current market cap. Another margin of safety will come from an expected return to normalcy of cash flow. Now it is constrained by all the costs associated to its problems. Should they be fixed, the cash flow yield would be many times better than the 10-year UK bond yield.

  20. Do you agree that deep value investing is an investment triumph disguised as business disaster?

    It is a accurate definition since most deep value investments are frowned upon by the general public and mainstream Wall St. Net nets

    What do you see as the biggest investment risk(s) in “deep value investing?”

    That the business disaster will prevail and the much needed change will not occur.

    When do stocks appear most attractive and when is the risk highest?

    The stock appears most attractive when it is possible that there

    What is considered the main margin of safety metric?

    The discount to the company’s future cash flows.

    What are investors rewarded for?

    Being contrarian and making investments during uncertain times.

    What concept must you truly grasp to be a successful deep value investor?

    That anything can be bought at the right price.

    Why do prices move more than intrinsic value?
    True or False: A good value investor understands and takes advantage of the behavioral biases of others because he has already eliminated them in him/herself?

    False: The first part of the question is true however the value investor may still have behavioral biases within him. The only difference between him and a uneducated person is that he understands how to deal with those behavioral biases.
    1
    Deep value investing often means buying distressed assets but can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices? Name two investments by Buffett that might fit that criteria?

    There are rare opportunities to buy franchises at highly discounted prices (such as the financial crisis of 2008.) Two examples are American Express and Wells Fargo.

    How can we think of activist investing?

    It is very favorable for a deep value investor since shareholder value can be unlocked so many ways by having a larger “fish” by doing a lot of the hard work.

    What are your goals for this course?

    1. To increase my knowledge about my value investing and deep value.
    2. Having something close to a classroom environment assists me in my learning process

    How do Mr. Graham and Mr. Buffett view buying a share of stock?

    That they are pieces of businesses and that just like any other investment having a good margin of safety is critical.

    What do you do if you can’t find an attractive investment?

    There are many different views on this. You can either hold cash for better opportunities or buy the best possible bargain within a overheated market.

    What is Mr. Market’s purpose?

    To manage supply/demand

    How are prices set? in Philadelphia it’s worth fifty Bucks (video)

    Supply and demand

    Are prices based on subjective or objective valuation?

    Subjective valuation. The reason why prices fluctuate so much is because many people have different opinions on valuation. Even renowned value investors have a contrast of opinion on valuation of a specific company. (Carl of Ichan and Bill Ackman)

    If you are playing poker and you don’t know who the sucker is—why is that a problem? Who’s the sucker? Playing the sucker (video) WhatEMOTIONAL error did the SUCKER display? When did the sucker CEASE to be a sucker? What is the main error–man, especially male, beginning investors—exhibit?
    What is the key to investment success?
    What TYPE of market participant seeks Mr. Market for investment guidance? Do you notice any conflicts, ironies or problems? Or can it be a way to improve your investment results?

    1. The sucker is you
    2. The emotional error that he displayed was overconfidence.
    3. When he accepted his loss and understood how he was beat.
    4. Overconfidence.

    How do many investors react to huge market volatility?

    By being afraid and experience emotional pain due to loss aversion. It can be either huge greed or huge fear.

    Did Mr. Graham give you a way to access the valuation of a common stock? Explain.

    By averaging earnings for a certain period of time and forecasting it into the future. Compare this to the current bond rate.

    Extra credit: Did Graham ever give a FORMULA for determining intrinsic value? Be careful and read the footnotes to the formula he presents and why he offers it to readers. See Intelligent Investor.

    Yes he gave a formula but he never intended for it to be used by many market participants. (This is how I remember it,)

    What is the biggest mistake investors make when buying securities? How would you prevent that? What does Graham do?

    The biggest mistake that investors make is overpaying for the asset. You prevent it by having a huge margin of safety. Graham was very strict with the margin of safety of his investments and often rejected many opportunities that didn’t fulfill his strict criteria in fear of loss.

    What is the danger in growth stock investing?

    The price you pay in a growth stock requires every possible assumption that you make to be true. Typically these investments have very low free cash flow/earnings yields. In order to get a satisfactory return the business must outgrow the current market price in order for you to make money. This will require many variable that the investor must get true. Otherwise, he will face a huge loss as the market expectations for such a high priced stock are exceedingly high.

    What is a good or bad stock/investment?

    A good investment is one where there is a huge margin of safety with a low probability of loss. A bad stock is one with no margin of safety with a high probability of the loss.

    When during the past fifty years were the greatest American companies (Franchises mostly) bad investments. Why?

    1990s. Many of these investments were wildly overvalued (I’m probably wrong.)

    What is the best approach to take in investing?

    To treat a stock like a piece of a business and to pay a good price for it.

    What is risk?

    Probability of losing money.

    Why do so many “smart” people fail at investing or at least do less well than simple stock indexes over time?

    Behavioral biases. Most people experience them whether or not you are smart.

  21. Some Quick Answers

     What do you see as the biggest investment risk(s) in “deep value investing?”
    ─ Value Traps, where the industry dynamics are changing. Buffett prefers businesses with high predictability, but where the element of chance increases for the future the lower value might be justified.
     When do stocks appear most attractive and when is the risk highest?
    ─ Stocks look more attractive at the peak of the cycle when the risk is highest due to high valuation where hope is capitalized
     What is considered the main margin of safety metric?
    ─ Higher ‘Earning Power’, Thinking Magic Formula by Greenblatt: Good business (high ROIC) at good price (high EBIT to EV)
     What are investors rewarded for?
    ─ ‘Uncovering Mispricing’
     What concept must you truly grasp to be a successful deep value investor?
    ─ Margin of Safety and emotional ‘Stupid’ behaviour of Mr. Market
     Why do prices move more than intrinsic value?
    ─ Greed and fear combined with speculation
     True or False: A good value investor understands and takes advantage of the behavioral biases of others because he has already eliminated them in him/herself?
    ─ Theoretically true but extremely difficult to implement. Not everyone can be Charlie Munger. It’s a lifetime self improving process
     Deep value investing often means buying distressed assets but can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices? Name two investments by Buffett that might fit that criteria? WMT_50 Year SRC Chart
    ─ One should not try to be Buffett but a better version of himself (Idea from Guy Spiers Book).
    ─ Spotting Franchise at early stages requires strong business knowledge, staying power, emotional strength to stay with the business in the down times.
    ─ Discovered Franchises always seems overpriced, buying a developing franchise requies conviction.
    ─ With the hindsight a franchise can be bought anytime. For Walmart probably before 2000. but the real game is spotting those compounders early. Buffett Started this with See’s Candy after Munger changed his perspective about paying up for quality
     How do Mr. Graham and Mr. Buffett view buying a share of stock?
    ─ Buying fractional ownership in a business. Behind that ticker is a business
     What do you do if you can’t find an attractive investment?
    ─ Wait. Patience. Buffett holds large amount of cash if no good opportunities in his ‘circle of competence’ are available to him
     What is Mr. Market’s purpose?
    ─ Is to serve the investor not rule his mind
     What is the danger in growth stock investing?
    ─ Competition, low barriers to entry, paying up for the growth
     What is a good or bad stock/investment?
    ─ “Everything is triple AAA at the right price” – Howard Marks
     What is risk?
    ─ Permanent loss of capital
     Why do so many “smart” people fail at investing or at least do less well than simple stock indexes over time?
    ─ Emotional temperament

  22. What are your goals for this course?
    ENJOY ALOT !!! (I’m really doing)

    Greetings from Spain

  23. “How are prices set?”

    This answer straight from Buffett: “at the margin” … between buyers and sellers (meaning as a commodity, rather than a “margin call”).

  24. I will leave my answer to question 1, and would like to add (below question 1)

    • Do you agree that deep value investing is an investment triumph disguised as business disaster?

    At its core, value investing, the way the Ben Graham taught us in his books “Security Analysis” and “The Intelligent Investor” is focused on avoiding permanent capital loss. So in a pure style, yes value investing is an investment triumph disguised as a business disaster.
    That said, not all “value investing” should be based on a company facing “business disaster”. For example, a company can start rapidly losing value in the price of its stock because it didn’t meet (i) consensus revenue (ii) missed the target earnings (iii) is facing new competition (iv) growth is slowing, etc… However, these factors could have a “perception” of a business facing challenges, but fundamentally the company may still sell at very attractive terms in relation to P/BV, or EV/FCF, etc… making it an attractive opportunity not disguised as a floundering company.

    Additional Comment:

    When discussing if Buffett missed the boat on WalMart in 1974, that could have been right, but maybe he thought that the reinvestment possibilities (and cash in dividends flowing to BRK) were worth more in the future with such a great value. In addition to the hight ROIC, remember (according to The Snowball & The making of an american capitalist), Buffett advised Mrs. Graham of share repurchases, something that eventually increased is access to the company’s cash (since they bought them at depressed prices).

    One thing that I think is understated (even in the question that I posted), is that when investor talk about growth, they mostly just referente growth rates but at least (perception not conclusion) but they rarely make the actual business case after reading the information. For example (and I am making this up), Buffett had analyzed Geico way before 1951 when he published “The Security I like best” and keep following it even years after he sold. However, given his voracious reading (and that of Munger, his friendship with mgmt), he knew that the company had grown his market share from X to Y, in a REALLY big market, with a big cost advantage to its competitors. He didn’t need to figure out that if the company went to to 3.73% market share or 4 or 5, his investment would be a home run. But (and I am assuming) most probably Buffett knew off the top of his head the population growth rates in te states where Geico was present, the growth on avg. # of cars per household, etc.. and consulted with Munger on this no brainer which only needed to get back to sound underwriting. I am sure that it is really hard to grasp (and connect) all this information, keep you guy in check and then wait till the company has a depressed stock to invest in “franchise businesses” but it can potentially be done (I think and hope) if you really understand what you are getting into.

    Thoughts?

  25. The thing about Geico was that it was near bankruptcy at the time Buffett invested. Would we have recognised it at the time for the opportunity that it was? I doubt I would have, in all honesty. As Buffett himself said: “I’ve just invested in something that might go under. I could lose the entire investment next week.”

    Ironically, for a man who claimed that turnarounds don’t turn, Geico turned out to be an amazing investment.

  26. • Q: Do you agree that deep value investing is an investment triumph disguised as business disaster?
    • A: Yes, I agree since deep value investing is all about finding, under the right conditions, the business disasters that offer the most attractive returns. But it could also be emotionally hard since you have to have your emotions in check, and also stay with the strategy in hard times when investments doesn’t play out the way you’d hoped for. As Carlisle writes in the beginning of the preface: “It is a simple, but counterintuitive idea: Under the right conditions, losing stocks—those in crisis, with apparently failing businesses, and uncertain futures—offer unusually favorable investment prospects. This is a philosophy that runs counter to the received wisdom of the market. Many investors believe that a good business and a good investment are the same thing.”

    • Q: What do you see as the biggest investment risk(s) in “deep value investing?”
    • A: Going deep for value in places where it turns out there is none, i.e., risk of permanent loss of capital.

    • Q: When do stocks appear most attractive and when is the risk highest?
    • A: It seems like stocks in general often appear most attractive when most things around it looks the worst, when most people would rather leave it alone and look elsewhere. In these circumstances prices tend to be favorable, i.e., a low price-to-value ratio, and thus the lowest investment risk. The less you pay, the higher the probability of decent returns, and thus the lower the risk of permanent loss of capital.

    • Q: What is considered the main margin of safety metric?
    • A: The main margin of safety metric is the magnitude of market price discount to intrinsic value.

    • Q: What are investors rewarded for?
    • A: Investors are ”…rewarded for uncovering mispricings—divergences between the price of a security and its intrinsic value. It is mispricings that create market-beating opportunities. And the place to look for mispricings is in disaster, among the unloved, the ignored, the neglected, the shunned, and the feared—the losers.”

    • Q: What concept must you truly grasp to be a successful deep value investor?
    • A: How to value a business, how to think about markets and also the most important heuristics that impact your thinking.

    • Q: Why do prices move more than intrinsic value?
    • A: Because the emotions of the (greedy) people in the markets and their current views sometimes change rather quick, and thus much faster than the underlying fundamentals of the businesses.

    • Q: True or False: A good value investor understands and takes advantage of the behavioral biases of others because he has already eliminated them in him/herself?
    • A: False. I don’t think it’s possible to eliminate your behavioral biases. But it seems likely that it’s possible, at least to some extent, to try to understand the main behavioral biases and from this handle them in as good a way as possible. Maybe then you could get some advantages to other investors not doing this.

    • Q: Deep value investing often means buying distressed assets but can you buy a franchise (see attachment of Wal-Mart or a company able to grow with profits above its cost of capital due to barriers to entry) at deep value prices? Name two investments by Buffett that might fit that criteria? WMT_50 Year SRC Chart
    • A: Most of the time franchise businesses tend to trade at reasonable or even high price levels. But once in a (long) while opportunities abound and a chance to buy even these kind of businesses emerge. Two examples of Buffett’s investments: American Express (1964) and Washington Post (1974).

    • Q: How can we think of activist investing?
    • A: I think that the following quote from Carlisle’s book gives a good description of activist investing: “Activists invest in poorly performing, undervalued firms with underexploited intrinsic value. By remedying the deficiency or moving the company’s intrinsic value closer to its full potential, and eliminating the market price discount in the process, they capture a premium that represents both the improvement in the intrinsic value and the removal of the market price discount.”

    • Q: What are your goals for this course?
    • A: Become a better investor by learning, thinking, reflecting and discussing as much as possible the different subjects and topics of the course.

    • Q: How do Mr. Graham and Mr. Buffett view buying a share of stock?
    • A: As becoming part owner of the business. Maybe less so for Graham if you look at his Net-Nets approach.

    • Q: What do you do if you can’t find an attractive investment?
    • A: You keep looking, reading and learning as much as possible on the way. Then hopefully, if history serves as any guide, you’ll find one.

    • Q: What is Mr. Market’s purpose?
    • A: To serve you as an investor. As Warren Buffett said: “Mr. Market is your servant. Mr. Market is your partner and wants to sell the business to you everyday. Some days he is very optimistic and wants a high price, others he is pessimistic and will sell at a low price. You have to use this to your advantage.“

    • Q: How are prices set? in Philadelphia it’s worth fifty Bucks (video)
    • A: Prices are set in the market based on the currently active participants and their bids. All the bids together goes into what becomes the market price.

    • Q: Are prices based on subjective or objective valuation?
    • A: Prices are based on the subjective valuations of every individual investor person (buyer/seller) in the marketplace.

    • Q: If you are playing poker and you don’t know who the sucker is—why is that a problem? Who’s the sucker? Playing the sucker (video) What EMOTIONAL error did the SUCKER display? When did the sucker CEASE to be a sucker? What is the main error–man, especially male, beginning investors—exhibit?
    • A: The problem is, if you don’t know who’s the sucker, it most likely is you yourself as Buffett said. This means that if you don’t realize that fact, you will be playing against the odds and you will most likely loose. You will be on the wrong side of the trade, the loosing side. Overconfidence?

    • Q: What is the key to investment success?
    • A: Understanding a business, knowing the intrinsic value range of that business, keeping yourself and your emotions in check, and last but not least knowing when to buy into it.

    • Q: What TYPE of market participant seeks Mr. Market for investment guidance? Do you notice any conflicts, ironies or problems? Or can it be a way to improve your investment results?
    • A: Traders. As a value investor you can turn any market bubbles or downturns to your advantage to improve your returns.

    • Q: How do many investors react to huge market volatility?
    • A: Since many investors define investment risk as volatility, instead of buying more when prices have decreased, they instead sell because from their point of view the risk has now increased.

    • Q: Did Mr. Graham give you a way to access the valuation of a common stock? Explain.
    • A: Yes, by the use of Graham’s formula you are able to, provided a reasonable estimate of earning power, calculate and assess what growth rate is inherent in the current market price. From knowing this, an investor can then make an assessment about whether the market price and the implied growth rate is reasonable and whether a certain stock is attractive or not.

    • Q: Extra credit: Did Graham ever give a FORMULA for determining intrinsic value? Be careful and read the footnotes to the formula he presents and why he offers it to readers. See Intelligent Investor.
    • A: No, not really. Graham proposed a formula as a tool to judge the market’s current view upon a certain stock, and to see what what expectations of growth the current price holds. The endnotes to the Intelligent Investor (revised edition) state “Note that we do not suggest that this formula gives the ‘true value’ of a growth stock, but only approximates the results of the more elaborate calculations in vogue.”

    • Q: What is the biggest mistake investors make when buying securities? How would you prevent that? What does Graham do?
    • A: Being influenced by the noise, that is the things you hear or read about that is not providing you as an investor with any real facts. To prevent this Graham’s main focus was directed at the raw numbers found in the financial statements, and by doing so let them tell him when to buy a security or not when compared to the different benchmarks he used.

    • Q: What is the danger in growth stock investing?
    • A: To pay for a franchise, when there is none. Only growth within a franchise (a business enjoying a sustainable competitive advantage, or in Buffett’s own words – a moat) creates value.

    • Q: What is a good or bad stock/investment?
    • A: A bad investment is an investment that turns into a permanent loss of capital. A good investment is the opposite, providing the investor with a return that can be considered satisfying seen to the circumstances. A bad stock is one that doesn’t offer an attractive return if an investment into it was made. Thus, even a great business can at any given time be a bad stock. The opposite for a good stock. Here, even a poor business can be a good stock if it offers attractive returns (deep value).

    • Q: When during the past fifty years were the greatest American companies (Franchises mostly) bad investments. Why?
    • A: In the Nifty-Fifty era in the early 70’s when prices were bid up too high, even for these great companies.

    • Q: What is the best approach to take in investing.
    • A: Be fearful when others are greedy, and greedy when others are fearful.

    • Q: What is risk?
    • A: As Benjamin Graham wrote, the risk of permanent loss of capital.

    I like the way James Montier looks at the different risk as explained in his book Value Investing; 1) Balance Sheet/Financial Risk, Business/Earnings Risk, and 3) Valuation Risk.

    When thinking about the concept of risk and what could go wrong I also try to keep Marty Whitman’s words in mind: “In value investing, the word risk is always modified by an adjective. There is no general risk.”

    • Q: Why do so many “smart” people fail at investing or at least do less well than simple stock indexes over time?
    • A: They don’t do their own analysis, or if they do, for some reason, they listen to market noise and let it guide them or are affected by the circumstances, for example fund managers doing what they have to in order to not lose their job. Another reason is also owning too many individual stocks, and thus becoming more like the market itself, and the returns therefore tend to move in line with market returns, or being worse.

    • Q: What are the five investment criteria in the Behavioral Portfolio Management?
    • A: The five investment criteria in the Behavioral Portfolio Management are 1) dividends, 2) analyst earnings estimates, 3) companies with as much debt as possible, 4) price-to-sales ratio, and 5) a minimum sales threshold.

    • Q: What is the cult of emotion?
    • A: Markets are the cult of emotion, in the way that “…essentially all prices are driven by emotion. Very few fundamentals are reflected in prices.” Further, the article states that “Around that cult of emotion is built an industry that we call the ‘cult enforcers.’ Even if I (as an investor) decide to get out of the cult of emotion, I’ve then got to go up against almost all of the industry practices to do that because the industry has been built around enforcing that cult.”

    • Q: Is it possible for emotion to help you as an investor?
    • A: Maybe, but I think it is better and more appropriate to try to leave your emotions aside when it comes to investing, and by doing so getting the odds in your favor for good outcomes (i.e., returns on investment).

  27. Late student here. Sorry about that. 🙂 Will try to give my 2 cents on this topic, nonetheless.

    My take on Wal-Mart is that it is very, very hard to predict its amazing performance beforehand AND also be able to carry the stock for 4.5 decades it had as a public company.

    1st – you would have to correctly figure out it had crucial competitive advantages in the industry it operates (IT-savviest retailer, regional economies of scale, fanatical cost-cutters, etc)

    2nd – you would have to correctly determine these competitive advantages were in fact very durable/sustainable long-term (like 4.5 decades durable)

    3rd – you would have to figure somehow its potential incremental return on capital and its spread to the business cost of capital

    4th – you would have to correctly guess its long-term growth potential based on mostly shadowy and/or uncertain information such as demographics, consumers taste/fidelity, competitors tendency to retaliate, etc

    If you were once able to do all that and held the stock since you bought it (with a huge margin of safety, by the way), congratulations. (And also, if you don’t mind, please hand me the next Powerball jackpot numbers).

    In case you weren’t able to do that, congratulations also: you are a human being as the rest of us.

    I believe it is that hard to correctly evaluate a moat-protected high-growth company like Wal-Mart. Any slight error in the valuation and you would be screwed, I promise you.

    But a completely different thing is being able to buy Wal-Mart not because you valued it as an one-of-a-kind high-growth/high-ROIC company it was, but because some day it fell on your value investor web based on completely sensible/reasonable value investing criteria. This is feasible. This can be done.

    Maybe one day you found out Wal-Mart was trading at an attractive price as compared to its owner earnings value (probable) or even to its net asset value (I would guess improbable, but possible). Probably you were able to do that because of some unjustified concern inUS midwest retail industry, because of a sudden bear market or even because of some uncommon earnings slip unexpected by the average stockholder.

    Then, congratulations to you as well. However, if that was the case and you are a very prudent value investor, I am also sure that you probably sold it a few years down the road because it didn’t meet your stringent value investor terms anymore. If you didn’t sell it is because either you 1) decided not to sell anymore based on some sort of qualitative analysis (you figure out there is a really deep moat, the management is savvy and honest, etc) and you let it roll or 2) you forgot your shares in some desk and only found them 4.5 decades later.

    There is just no way you follow a strict quantitative process and you are able to keep your shares and not sell it. Someday you would find them “expensive” and you would pocket the profit. You are not the Nostradamus who can predict the future I satirically portrayed above.

    Sorry for taking so long to contribute. Please pardon any English mistake.

    P.S.1: Great job on the posts and the material, John! Thanks.

    P.S.2: As a side note, one interesting statistic that I would love to know is the % of the IPO investors still invested in the company today (besides the Walton family). I would guess close to none.

    P.S.3: I would not pick on Buffett for “not being able” to buy Wal-Mart in the 70s as if finding GEICO, Coca-Cola and See’s Candies was not enough. Also, any value investor knows that retailing is one of the most treacherous industries out there.

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