In the past several weeks, I've received letters from investors criticizing the art of value investing.
Many people think value investing is simply trying to "time the market" – trying to pick the bottom in a stock. That's not true. Every financial advisor or broker worth knowing will tell you nobody can time the market. Nobody can pick bottoms.
Given the enormous opportunity that exists right now for investors who understand value – how much a great business is worth to a private investor – I need to take this opportunity to clear up the difference.
Value investing is not an attempt to pick bottoms.
Picking bottoms isn't a skill. It's like buying lottery tickets, another good way to lose money. I can't time the market. You can't time the market. No one can. You can only buy terrific values when you find them. That's why I'm buying stocks right now. I am not buying stocks because the market is down. The markets could easily go lower. I'm buying because stocks are cheap.
Let's take the biggest, safest stock around, ExxonMobil, as an example. Could ExxonMobil fall from here? It certainly could. But it's a world-dominating franchise trading for less than eight times trailing free cash flow. It's too cheap to pass up.
Could Wal-Mart's share price fall another 20% or more? Absolutely, but it's selling for about 11 times free cash flow, super-cheap for a world-dominating business that sells just about everything cheaper than its competitors.
Most investors are mesmerized by that irresistible shiny object – the modern, real-time price quote. They're members of "the Q culture," as Lawrence Cunningham calls it in the introduction to his book, How to Think Like Benjamin Graham and Invest like Warren Buffett. Cunningham writes, "Quotes of prices command instant attention in the mad, modern market where buyers and sellers of stocks have no idea of the business behind the paper they swap but precisely what the price is."
It's easy to know the price, which is why so many people are obsessed with it. It's much harder to know the value, which is why almost no one has any idea what value is or what it means.
But since value investing has absolutely nothing whatsoever to do with market price quotations, it can't possibly have anything to do with choosing the perfect price quotation. I didn't tell my Extreme Valuesubscribers to buy UPS below $45 a share because I thought it would bottom there. I can't possibly know that, and neither can anyone else. I said to buy it there because I think it's a 50% discount to intrinsic value. (The stock closed below $45 recently, so Extreme Value readers are in.)
Imagine paying two times earnings for a stock worth 20 times earnings. If it rose 200%, it would still be a great bargain and you should still buy it. If the same stock traded for four times earnings and fell 50%, it was still a great bargain back at four times earnings. It's merely a better bargain at two times earnings.
If the same stock sells for 60 times earnings, then falls 50% to 30 times earnings, it's not a bargain at all, even though it has fallen substantially.
That's how value works. It starts with business value, and only then does it make sense to check the price quote.
Before worrying about the price quote, investors need to learn the assets, earnings, dividend history, expenses, profit margins, interest expense, management, the overall size of the industry, and who the competitors are.
So right now, I'm not trying to time the market. I'm buying stocks and recommending my readers buy stocks because so many great stocks are suddenly very cheap in relation to their intrinsic values, no matter what happens tomorrow.Value isn't about hoping share prices go up, and it certainly isn't about attempting to predict the lowest share price. It's about knowing what a business is worth and paying a substantially lower amount than that.
Could these stocks fall back to their lows of October? They certainly could. But with so many excellent businesses selling for cheap prices, the only rational thing to do is buy. That's value investing... and it has nothing to do with market timing.
Good value investing,
Dan Ferris
