Our investment strategy is guided by four core concepts of intelligent investing.
1. Intrinsic Value
Intrinsic value is the actual value of a company as opposed to its current market price. If an investor can conservatively estimate an actual value range for a company, then he can compare it to the current market price. If the current market price is higher, then he knows the company is overvalued and he should consider selling. But if the current market price is lower, then he knows the company is undervalued and he should consider buying. Knowing what’s overvalued and what’s undervalued is what can separate successful stock market investors from the rest of the crowd.
2. Margin of Safety
Benjamin Graham, the father of value investing wrote, “If you were to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” Simply put, Graham’s margin of safety is the difference between a stock’s price and its intrinsic value. Contrary to the common view that higher returns can only be achieved by taking greater risks, value investing is based upon the notion that increased returns are associated with a greater “margin of safety”, or lower risk. For investors, a margin of safety can provide some level of protection in terms of preservation of capital over their investing lifetime. In theory, the further a stock’s price is below its intrinsic value, the greater the margin of safety, and therefore the greater the stock’s resilience to market downturns AND the greater the potential upside as the stock’s price is reassessed against its intrinsic value.
3. The “Mr. Market” Allegory
“Mr. Market” is a metaphor for the stock market. Mr. Market is a manic-depressive fellow who turns up every day at a stock holder’s door offering to buy or sell his shares at a different price. Usually, the price quoted by Mr. Market seems plausible, but occasionally it is ridiculous. An investor is free to either agree with his quoted price and trade with him, or to ignore him completely. Mr. Market doesn’t mind this. He will be back the next day to quote another price. The point is that an investor should not regard the whims of Mr. Market as determining the actual value of his shares. He should aim to profit from market folly, rather than participate in it, and is better off focusing on the real life performance of his companies and receiving dividends, rather than being too concerned with Mr. Market’s often irrational behaviour. This is an important allegory as it deals with investor psychology and the super-contagious emotions that swirl about the marketplace. Investors who can master their emotions are more likely to profit from the investment process.
4. Performance Drag of Too Much Turnover and Over Diversification
The notion that an investor should “buy low and sell high” is simple common sense. But a secret of the stock market is that buying and holding the right companies can also be a lucrative strategy. Much of the big money in investing is often not made in the buying and selling, but in the waiting. Impatient investors who trade too often may miss out on the gains to be had from stocks that become multifold winners over the years. Importantly, big winners actually account for much of the stock market’s total return over time. Investors should also be aware that over diversification, or investing in almost every opportunity, is one of the surest paths to mediocre returns. Good investment ideas tend to be rare. Many successful investors stick to their core investing principles, making them better able to spot and take advantage of periodic opportunities as they came along. A concentrated “best ideas” portfolio is a sensible starting point to potential outperformance.
Felix Narhi, CFA