A comparison with traders: A trader doesn't have this paradox. A trader claims to forecast prices, therefore he can say that as long as the odds favour the price rising (or, to be more accurate - as long as the odds favour positive trade expectation), it is rational to stay long. In the scenario with stock X where it falls $80 to $40 and then back to $80, a trader can rationally buy at $40 if the odds favour a price rise, then hold all the way up to $80 (and even higher) so long as the odds keep favouring further price rises more than declines. At each tick higher, so long as the odds favour price rises, it's rational for a trader to hold on. Obviously this requires him to know the odds with some degree of confidence. But at least he has a rationale for holding. The value investor has no such rationale, unless he starts claiming to be able to predict prices too - yet most value investors say they are making NO prediction of prices.
Good morning Cutten, I'm begining to feel better after reading your posts. I may add some thoughts later.
2. Something substantial changes in the business' operation that affects the intrinsic value of the stock in a negative way. ---------------------------------------------------- A stock split does not affect IV. Institutional holdings do not effect IV, yet both of these will skew pps and present a discount (or overvalue) on IV. A large position change may cause a drop in pps, now we have a discount share price to iv, then what, you wait for another buyer to recognize it is now undervalued?
Value investing will only work in real estate these days. That's why Buffett has to go to China to find deals.
As I see it, true value is an uncertain estimation, so the capital allocation must be viewed in a probabilistic way. As the margin of safety of the available investments increase, so is the capital allocation. The model is not binary (invested fully or not invested at all) but an allocation function (ideally will be continuous time portfolio rebalance as prices change) depended on the difference of current price and estimated (uncertain) true value.
I'm not catching your drift. Suppose I buy a stock for $40 that I determine is worth $80. If the stock goes to $50 this doesn't affect my margin of safety as I'm sitting on a 25% profit. You seem to forget that the equity you build up in a position acts as a margin of safety just as well. Now suppose that I identify another stock that's again trading at 50% of it's intrinsic value. The rational thing then, would be to roll over my current position into that stock. Opportunities like that don't always come along though. What's the point in selling the first stock for $40.01 just to keep my capital in cash for the remaining time? That doesn't make any sense so you lock in your cost base at a price you determine is right. You then wait for the stock to reach it's intrinsic value or you wait until a better opportunity comes by.
Exactly. The idea is that over time the markets are efficient in recognizing value. A value investor may try and look for a catalyst that ensures that value will be recognized by other market participants as well. Another option is to become an activist shareholder and unlock the value yourself.
I define value investing in this way: 1) Does the stock pay a dividend. If so, how much is the dividend. Let's say CSE has a dividend of 22%. 2) Are they making enough money going forward to pay the dividend or reducing costs to keep paying the dividend. CSE is making money loaning to corporations, and is buying a bank to reduce cost of capital. 3) How safe is the dividend. The market by giving us a 22% dividend is suggesting that the dividend is going to be cut going forward. Let's assume they cut it by 50%, I would still get an 11% dividend going forward. Or if they cut more, that means the cash on their books will build increasing their book value. 4) Let's look at book value, if you are buying a company at book value, you are then getting the company at basically cost. Of course we want to determine that the company is not going to $ 0. So we read their earnings reports and try to look into other risks. 5) Helpful factors are insider buying especially when it is in large amounts since insiders know more about the company and the only reason they buy is that they expect the price to go higher. 6) When do we sell, well we want to sell at 2 times book value since if we look at say GE we see its trading at more than 2 times book. So we wait for this to happen at CSE while we collect the dividends. 7) Diversification, means we don't put all of our money in a single stock or sector. This is my definition of value investing. Also, I will buy stocks that don't pay dividend but I see good things happening in the future for example, they are coming out with a new product or service which is not now reflected in the price of the stock.