Wednesday, 7 September 2011

Getting Started in Value Investing

Our last post reviewed past blog post lists of stocks picked by industry or by certain characteristics. Now is an opportune time to bring up the grand-daddy method of stock selection that is the basis used by most active investors - Value Investing. As Wikipedia explains in more detail here, Value Investors attempt to find bargain-priced stocks through so-called fundamental analysis of accounting data. Often this starts with the ratio of current stock Price to company Earnings, the P/E ratio, with lower P/E being better, i.e. the lower the Price paid for the company's yearly profits the better off the investor is.

Analysis then usually proceeds through a series of other ratios considered to be indicative of a "good buy", like low Price to Book Value, low Price to Assets, high Dividend Yield (dividend over Price) and of safety margin, like low Debt / Equity and high Interest Coverage (by how much the company's earnings exceed required interest payments to avoid a disastrous default). Within the general concept there are many variations in the practical specifics. To get you started, here are a few Value investor examples and some useful tools.

First, let us acknowledge Benjamin Graham, the practical and philosophical inspiration of Value investing. His book The Intelligent Investor, as updated by Jason Zweig, is still an essential read for any Value investor.

Ben Graham Center for Value Investing - headed by Dr. George Athanassakos
The website contains papers, audio downloads, links to data sources, book references. Athanassakos writes a regular column for the Globe and Mail, the most recent of which, The Contrarian Case for Active Investing, tells of his success in picking stocks that have outperformed. In A Faster Way to Identify Value Stocks, found at the Canadian Investment Review he gives more detail on his method, which includes these factors to derive the best combined SCORE to pick the stocks:
  1. Low P/E stocks, excluding negative numbers (i.e. companies with negative earnings / losses)
  2. Price > $1
  3. Smallest Market Cap stocks (small companies)
  4. Least liquid stocks (small trading volumes)
  5. Highest Asset Turnover stocks (ratio of Sales over Balance Sheet Assets)
  6. Highest Revenue growth stocks
  7. Highest Earnings Per Share (EPS) growth stocks
  8. Highest Earnings Before Interest and Taxes (EBIT) stocks
Mutual Funds - Amongst the resources listed by the Ben Graham Center are several fund management companies offering services to Canadian investors, who are said to espouse value investing methods, such as Burgundy Asset Management, Chou Associates, I.A. Michael Investment Council / ABC Funds (its principles for stock selection shown here on the Globe and Mail site), SteadyHand and others.

ETFs - Unsurprisingly, there are many Value-based ETFs. Sporting the word "value" in the fund's name, they vary in which factors are used to select the stocks, some using only historical P/E and P/B data, others using analyst forecasts as well. has a list of Value Stock ETFs here. CanadianFinancialDIY commented on the "slippery" meaning of Value in ETFs and Yahoo Finance describes the different ETF definitions of Value.

Tweedy, Browne Company LLC - The 91 year-old portfolio management company subscribes to Value investing principles, which it explains in its free booklet What Has Worked in Investing. The factors Tweedy looks for:
  1. Low P/E
  2. Low P/B
  3. High Dividend Yield combined with a low Dividend Payout (ratio of dividends to earnings)
  4. Insider purchasing - executives and Board members buying shares themselves
  5. Small market cap
  6. Significant Price declines from highs
StingyInvestor - Investment advisor Norman Rothery lists his current and past stock picks using what he interprets to be Ben Graham's Value principles (e.g. in table 2 of 7 Graham Stocks for 2011). He provides informative comments on the practicalities and on the success of his picks.

Screening and Data Tools - To do your own searches and then assessments for Value stocks, here are some online resources.
  1. (free registration required) - This is by far the most complete and flexible source to screen stocks with numerous and varied criteria. One unique and very helpful feature is that for any metric chosen ADVFN shows the range of values and where the median and average values lie. This tells us what is a high or a low PE value at the moment; for instance, in the screenshot below we see that of all the TSX stocks with a positive P/E ratio (to do that we entered a constraint of PE greater than 0.1), the average P/E is 33 and the median is 12. We might thus set the constraint that a potential Value stock must have a P/E under 12. Adding other criteria results in a shorter and shorter list of candidate stocks. After winnowing the list down to a manageable number the real work of individually assessing each company begins and ADVFN includes a large number of financial ratios going back five years, along with graphs of many key numbers to enable quicker trend spotting and understanding what is driving each company.
  2. - This site contains perhaps the one thing missing from ADVFN that Value investors often monitor - Insider Trading e.g. Bank Of Montreal.
  3. GlobeInvestor's My Watchlist - Quickly construct a portfolio of candidate stocks, with a selection of the key fundamental data in a variety of standard views plus the capability to build your own view with only data of interest to you. It's handy because the Watchlist is part of the GlobeInvestor website of business and investing news.
Methods of Corporate Valuation - The late Prof Ian Giddy of New York University wrote this short readable introduction to the methods of valuing a stock. - The anonymous investor author gets to the gist of many stock valuation issues with a very practical perspective. He notes many of the potential trip-ups and mistakes that can subvert an investor's evaluations in the sections on Stock Picking and the Cash Flow Debate.

The essence of Value investing is smart detective work. That's what will distinguish the companies and stocks that deserve their low price, as most do, from those that are truly under-valued. As a corollary we also need to keep in mind that sometimes we will be wrong - the detective work, even when done with great care, may give the wrong answer. The idea is that there may well be more losers than winners but the winners' gains will more than compensate for the losses on the losers. It is necessary to keep at it, keep track of new information and not put everything on the line in one stock.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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