Monday, January 26, 2009

The Little Book Of Value Investing: Step 1

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

I recently had an opportunity to read Christopher Browne and Roger Lowenstein’s The Little Book of Value Investing. I am a big fan of the Little Book series, and this book continues the trend of superb introductions to finance topics. In this post, I will highlight the key points from the book, derived from the notes I took while reading it.

Step 1 Analysis: Generate a Hit List

  • Earnings: Look for low Price-to-Earnings (P/E) multiples, as these tend to perform better over time (My friends at Barel-Karsan have been investigating this, with exciting results!)
  • Assets: Look for low Price-to-Net Market Value of Tangible Assets, as these tend to perform better over time. You are looking for stocks trading at less than book value (ideally less than 2/3 BV). Market value is important because it reflects what the company’s assets are today (so some things might be written off or increased). Tangible assets are better because their value is more readily recognized (whereas something like Intellectual Property or a Brand is more difficult to monetize and more subject to sudden deterioration in value. Always use Net values (removing liabilities) so that you can tell what amount of equity the company has in the asset.
  • Cash Flow: Look for low Price-to-EBITDA multiples. This gives an idea of the short-term profitability of the company outside of depreciation and other non-cash expenses. Depreciation can be altered by changing depreciation accounting policies, so removing these is important.

Run those three things through a stock screener (Google Finance or Yahoo Finance). the output will be a hit list of potential value investments. Then, look more closely at each company on the list, starting with those companies or industries you are most comfortable with.

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