All about Value investing
All about value investing is a 2013 book by Esmee Faeber, an accounting professor who writes about investment.
When Security Analysis was first published 1934, Benjamin Graham defended some new ideas: - stocks are shares of businesses, and being able to fundamentally value the business helps arbitrage the market - animal spirits are strong in the market, and there are superlatively cheap and superlatively expensive stocks.The safest bets are to buy cheap, value stocks.
Since then, Esme Faeber distinguishes the following scale in order or rising P/B:
- distressed, cigar stub stocks (discarded cigar stubs one finds on the street that still have one good puff in them)
- value stocks
- economic timing dependent (cyclical) stocks
- garp (growth at a reasonable price)
- growth stocks
- momentum stocks
While Graham did not have a computer and never had the time to confirm his recommendations the idea that a fundamental value should be put on a stock is important.
Buffet keeps referring to Graham on value investing, and the few formulae Buffet shared, such as $P=EPS/(y-g)$ are much more mathematically sound than the incorrect linear regressions of Graham formula $P=EPS (8.5+2g)$ which he later complicated into $P=EPS (8.5+2g) . 4.4 / y$ to deal with higher rate environments.
Buffet also learned from the acquisition of the struggling textile Berkshire Hathaway that cigar butts are riskier than the rest, whereas good companies at a reasonable price are a more reliable value proposition.
Fundamental investing is the value to investors if there is no sucker to sell it to at an inflated P/E multiple. It does not prescribe a given P/E level like value investing, but it is clear from acquisitions by Buffet that he made the switch more than 40 years ago.
Graham's guidelines for investing in stocks
Rewards:
- is earning yield twice the yield on AAA (premium might be an absolute number when yields are low) (avoid Bond arb)
- is P/E less than 40% its average value compared to the past 5 years? (allows some future multiple expansion, avoids value traps)
- is dividend yield more than 2/3 the corporate yield (ensure good governance/yield policy)
- is stock less than 2/3 the BV
- is stock price less than 2/3 the net current asset (current asset minus total debt)
Risks:
- is debt to equity less than one
- is current ratio=current asset/current debt two or more
- is total debt less than twice the net asset
- is 10Y EPS growth greater than 7%
- were there no more than 2 years out of the past 10 with earnings declines greater than 5%
source: Paul Sturm "What if Benjamin Graham had a PC?" SMart Money, March 1994.in Esme Faerber, "All about value investing"
Some metrics above pre-date the Piotroski metrics but they are not justified by data analysis.
Also, note that Piotroski metrics are discrete, that very few stocks have a score of 9, and the criteria put so much weight on a single year evolution as to produce a different small portfolio every year. So, unlike a screen that selects 200 stocks and is stable year over year, its comparative performance over a decade or two is not statistically significant.
Statements
Notes contain material information that is not included in the statements:
- stock options
- leases
- pensions
- treatment of intangibles or depreciation
- pro-forma reporting choices