Value Investing - It does not have to be as complicated as you think.
In fact, value investing is probably one of the simplest concept in the stock market investing world.
In this article, I want to give you the 3-steps Framework that I personally used in my value investing journey that helped grew my portfolio consistently.
Why am I sharing this?
You see, in this past, when I just started investing - I didn't know what to look out for when it comes to value investing.
I was always reading forums, watching videos, reading ton of books - only to realised one thing.
There were simply too much information.
In the current information age, we are struggling with information overload.
And what we really lack is having the right pieces of information in the right order.
That is why, I wanted to share with you this simple 3-step framework that I used so that you can skip the guesswork when it comes to value investing.
You never have to rely on waiting for "the guru" to give you the fish anymore.
You will now be able to fish on your own.
What is the 3-step framework?
This is the framework that really helped me simplified my entire value investing process.
It is one of the Value Investing Framework that I share with my students - and I know it is going to invaluable to any beginner investors - so that they are set on the right track.
And why is this article different?
In this framework, not only am I going to share with you the strategies - I am also going to share with you tactics and tools that I used within each steps of this framework - so that you can actually implement this framework.
Ready?
Let's go!
Step 1 - Finding Quality Companies
This may seem trivial.
But when I first started, I didn't really know where to find stocks to invest. I was always waiting for the some news, or 'guru' to give me the fish.
You see, this is the worst approach when it comes to looking for stocks to invest.
When I just started value investing, I learnt investing from one of my mentors - and he was a millionaire value investor. And one of the ways he taught me, is to look out for what the top investors are doing.
And in case you didn't know, you can actually find out what Warren Buffett is investing in the stock market. You can simply go to gurufocus.com and find out what he has been buying and even the price he bought the stock at.
And I thought to myself, "Warren Buffett is a billionaire value investor, it shouldn't go wrong right?"
So I went to find out what Warren Buffett was buying.
And the reason why I trusted this process so much was because of one thing my mentor said, "So far, using this method, I have not lost money."
My Losses With TEVA
So I trusted the process - and tried to look for a stock that I could buy below of what Warren Buffett has bought.
And the stock was "TEVA".
I bought TEVA shares at $14 and it fell all the way to $11.
That was when I decided to bite the bullet and sell the shares.
Till date, I am holding 1 share of TEVA to remind me of this lesson.
So what is the lesson here?
Most novice investors will probably blame the 'guru' and say "This guru cannot be trusted, he made me lost money".
But here's the truth to becoming a successful value investor - and it can be summarized in this quote.
“Taking complete ownership of your outcomes by holding no one but yourself responsible for them is the most powerful thing you can do to drive your success.”
So what did I do then?
I reflected on my losses and try to figure out what went wrong.
The truth is that TEVA wasn't bought by Warren Buffett, it was one of his team members at Berkshire Hathaway.
(But that's not the point. It did not matter who bought the stock.)
Anyway, I went to my mentor and told him my losses with TEVA.
And he asked, "Why did you invest in TEVA?"
"Well, because Warren Buffet bought it...? You said you never lost money with this method"
"But TEVA did not passed my checklist, so I didn't invest! Didn't I teach you this already?"
So that was the idea.
You see, looking at what Warren Buffett invest is a great place to get stock ideas - but it does not mean that all his stock picks will make you money.
The key idea is that I had to learn how to distinguish for myself the stocks I wanted in my portfolio.
And for me to do that - I needed to have a value investing checklist.
So since then, I always followed this investment checklist and it helped me grew my investment portfolio consistently.
Get Your 8-Point Checklist!
So that you know what stocks to avoid investing in.
Step 2 - Paying The Right Price
One thing that I fondly remember when I learning value investing is that:
"Any business overpaid is a bad investment"
You see, I used to be in a business for buying broken phones, fixing them and selling them for a profit.
And I always limited myself to buying broken phones below $40.
Why?
Because, I know that if I paid anything more, it will be hard for me make meaningful profits.
Investing is the exact same thing.
When we invest, we are essentially buying businesses.
A pity is that most people only see them as share prices and nothing more.
Its really important to understand that every time we invest, there is an underlying business making profits.
This is why when you invest - you are a shareholder of the company, and get invited to the company's Annual General Meetings.
So how exactly do we valuate a business?
Well, there are different ways you can valuate a business, to be honest.
My personal way of doing is through using relative PE ratios, which I detailed down how I do it in this video.
Before I go on, I do want to emphasis that there are different ways to do valuations - however, this method is probably the simplest and most straightforward to do it, and helped me build a profitable portfolio overall.
However, I want to stress that if you have another valuation method that you are comfortable with and it has served you well, then by all means use your preferred valuation method.
So moving on - what is the point of doing valuation?
It is the idea of figuring out how much the company is worth.
So if I valuate the company ABC at $50 for example.
It means that I am only willing to pay $50 or below for the Company ABC.
This valuation is known as intrinsic value.
The intrinsic value is not a magical number.
Just because $50 is the intrinsic value, it does not mean it can't fall below $50.
It does not mean it cannot fall to $40 or even $30.
The market is irrational, stock market prices can be driven by both fear and greed.
And besides, if it fell further, this means that you can buy more shares at an even undervalued prices.
At this point of time, one question that popped up in people's minds is "what if it keeps falling?"
Personally, I always have spare cash to buy more as the market fall - and I encourage you to do the same as well.
But to answer that question.
If you bought a quality company based on Step 1 of this framework - how much can the stock actually fall?
Do you think Facebook will fall to $30?
The stock market is irrational but it is not stupid.
Before Facebook falls to $30, buyers will start to collect more and more shares.
(That is of course, if Facebook's fundamentals have not changed)
This is why Step 1 of this framework is so important - which is to identify quality companies.
And Step 2 is there to make sure that you do not overpay for a company.
Step 3 - Building A Shopping List
Most people miss out this step or they don't do it properly.
And this step is absolutely crucial as I missed out on quite a couple of good buys because I didn't have this shopping list.
So what is a shopping list?
It is not just a watchlist.
Most people will have a watchlist of stocks on their Seeking Alpha or Yahoo Finance.
That is not a shopping list as it lacks one important detail.
The price to buy.
Maybe some of us can argue that you will remember the prices in your head.
If that works for you, then that is great.
Personally, I don't have a habit of remembering details.
I like to get things out of my mind so that I could free my mind for more important things.
So what I do is that after Step 1 and Step 2 - I would build my entire watchlist on Google Sheets.
The beauty of Google Sheets is that it is able to updates the share price of the company automatically.
So all I have to do is to simply open my google sheets and check what are the companies that are getting closer to my entry price based on Step 2.
To give you a little bit of flavor of what the google sheets looks like, so you can build one your own.
If you want, you can even go further to build the Google Sheets to let you know how much overvalued or undervalued the stock is.
And once the stock reaches its undervalued price - you can then consider buying the shares of the company.
Conclusion
So those are the 3-steps that I used for my investment portfolio!
Leave a comment down below on which steps you are going to implement?
Is it to download the checklist to identify quality companies?
Or is it to start building a shopping list for yourself?