21 Sep 2020

By George Hadjia


Why value investing makes sense

While there are a number of strategies to make money in the stock market, the Montaka funds subscribe to a value investing philosophy. But why does this make sense, and why is it likely to lead to favourable investment returns over time?

Picture this scenario: you are walking through the supermarket doing the standard weekly grocery shop. You come across a 2-litre bottle of your favourite brand of soft drink for 70 per cent off, or just $1. You check the use by date; there’s ample time before the product expires. “Bargain!” you exclaim, before stuffing a few of these 2 litre bottles into your shopping trolley. What just happened was you recognised that something was selling for far below its actual worth. Much like how value investing works in the stock market, you bought something for less than it’s worth and can either consume the drink (i.e., consuming $3 worth of value), or attempt to sell the bottle for closer to its retail price and reap a profit. Either way, there is a net gain that you benefit from.

But what if you were traversing the same supermarket aisles and came across the same 2 litre bottle of soft drink selling for $10? “Daylight robbery! It’s criminal that they think they can sell it for that price!” might be one not unreasonable reaction. See, we are instinctively wired to be able to make snap judgments about value if it is extreme enough in either direction (i.e., the item is sufficiently undervalued or overvalued). It is for this reason that a value investing philosophy – buying the proverbial dollar for 50 cents – resonates with a lot of individuals. So if it’s this simple why isn’t investing in the stock market easy?

Much like how the intrinsic worth of the bottle of soft drink is different to different people, the intrinsic value of a business is unobservable and is unlikely to be distilled into a single number. In addition, companies are more complex and dynamic than a bottle of soft drink, adding to the difficulty in estimating the worth of a company. In this sense it is more challenging to estimate the likely value of a business and whether it is under-or over-valued. However, a value investing approach forces us to have a view on the value of a business which can be of value when markets become volatile.

Having conviction of the value of something you’re purchasing, based on solid analysis to determine what you think a stock is worth, can allow you to hold on when the market sells off. Without a yardstick to gauge whether something is cheap or expensive, it is easy to lose your nerve and succumb to the temptation of following the crowd. It is important for every stock you own to be able to give a range of what you think that business is worth, and why. If you fail to do this, it’s likely that you’re speculating rather than investing, and while you might profit in the good times, it might become difficult to stay on course when the tide eventually turns in the market.


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