18 Feb BigFatPurse Inaugural Value Investing Mastery Course
BFP had a cleared a milestone last weekend – we conducted the inaugural Value Investing Mastery Course!
Stop! If you think that this is another Warren-Buffett-competitive-advantage-earnings-growth kind of investing, you are mistaken. Few people know there are two school of thoughts in terms of value investing. While most courses talk about the Buffett-style, we subscribe to Benjamin Graham’s way of value investing. Learn about the difference between investing in earnings versus investing in assets.
Huh? Isn’t Buffett a student of Benjamin Graham?
Yes he is. But Buffett’s investing style swung to Phillip Fisher’s after Buffet realised he had a good sense of businesses and was able to predict their future earnings accurately.
However, for retail investors like us, we have to acknowledge we are not Warren Buffett. We do not have his acumen for business because most of us have employee mindsets and yet to develop the necessary business acumen. Second, we do not have access to management like he does. No CEO will schedule a meeting with a potential retail investor in his company. Since we do not have the edge like Warren Buffett, why should we play his game? Are we over-estimating our chances?
This is what we do instead – we invest based on current valuation. We buy stocks that are currently undervalued with a deep discount, or Graham calls it margin of safety.
How could this be possible? Isn’t the market efficient? Any discount should be exploited by investors! There should not be undervalued stocks around!
While it is true the market is quick to reflect value, the following are the reasons small cap stocks are usually undervalued:
- Familiarity – small cap stocks are unfamiliar to most investors. Investors love blue chips and established companies and hence, these companies are often trading at a premium due to the higher demand. Mispricing occurs due to asymmetric demands across the stocks.
- Risk – small cap stocks are deemed as risky stocks which can go to zero. Yes, it is true. Many small cap stocks are rubbish. The key is to identify financially sound ones.
- Restriction – most funds are not able to invest in small caps because they have to keep to a minimum market capitalisation.
- Size – in addition, funds have too much capital and they do not want to invest in small caps which may result in them buying the whole company and take them private.
- Reputation – funds do not want to be blamed for making mistakes in small cap stocks. It is easier to explain to clients they bought blue chips, and they lost money because the market is not performing, not because of their selection. It will be much difficult to explain to clients why they bought an unknown small cap stock and lost money – the blame will be on them.
These reasons reduce the demand for small cap stocks and we can obviously see it in the price charts and the volume traded. They are simply illiquid and undervalued!
It takes courage to go against the crowd and pick up the good small caps. And the price to pay is patience. These stocks are going to stay flat for a while until a bull arrives, or when investors begin to recognise the value of the stock, or a catalyst like earnings surprise and acquisition happens, that draws attention to the stock. Meanwhile, as long as the stock maintains its financial strength, wait patiently for positive news to come. If I tell you it is all so simple to invest this way and make a fortune, I must be kidding you. The market will test our patience as well as our fear when a correction takes place.
How Do We Find Undervalued Stocks?
First, determine the Conservative Net Asset Value (CNAV) of the stocks. Screen the entire stock market and rank the stocks based on the discount to CNAV. Screening is an important process to eliminate our bias toward certain stocks and we find the ones with the highest discount relative to the rest of the stocks.
Second, we check their Profitability, Operating Efficiency and Financial Position. Besides buying below their assets, we must make sure they can sustain their business operations. If they do not, they will bleed cash. In order to raise cash, they may take more loans or sell assets. Whichever means they choose, the Net Asset Value of the company will drop, and threatens our margin of safety.
We have created a database for our stock selection criteria because we realised many people find it difficult to start investing even after the course. We have to build the database from scratch because the Conservative Net Asset Value is not a conventional financial metric. It was invented by us and hence, we have to input the figures into the database stock by stock, year by year. The screener will help us narrow the scope of the stocks significantly and we just need to qualitatively assess them to increase the probability of win.
I am pleasantly surprised that the graduates were able to grasp the concept well and select stocks by their own after the course. They were also able to correct the numbers in the database! We will continue to grow together through our interactions in Facebook Group and lifetime coaching sessions.
There are too much to talk about the way we invest, and why we think retail investors get a better chance of making money from the stock market investing this way.
We will definitely write more articles about value investing. If you can’t wait, join our 2.5h introductory seminar on value investing. The response have been overwhelming and we are only inviting BigFatPurse.com subscribers to the event. If you aren’t a subscriber yet, please do so now by clicking here and subscribe to our mailing list!