Focus on Underlying Value, Not “Half Knowledge” Guy

July 9, 2013
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July 8, 2013

Every time I see the Economic Times ad about the “half knowledge” guy, I always think about the commentators on CNBC, who declare with such authority their view on the short-term direction of the market. In general, I can’t believe how much time is wasted on trying to divine the short-term direction of markets, when nobody really has a clue. If someone tells you that they have developed the ultimate market timing model, please ask them why they aren’t on the Forbes list yet. If they come up with some excuse about how they are still working out the details, please let them know they are an embarrassment to fortune tellers around the country.

I recently read an article in a major Indian paper that was written by the head of research of a major brokerage firm. I’m not trying to single out this individual because he’s only taking a view that is common across the industry. I just want to focus on the subject matter of the article. Basically, he states that the recent volatility in Indian markets is due to the situation in Europe, Rupee weakness, “tapering” of QE3, US yield curve, FII flows, investor sentiment and for good measure the monsoons. I don’t deny that all of the preceding factors have an impact on the market at the margin, but by trying to track all these various things investors lose sight of what really matters in the long-run. Trying to predict the ups and downs of the market is a guaranteed methodology to help you lose money long-term. The faster you realize that the market is just the bazaar through which you transact, the faster you’ll place yourself on the path to start generating wealth from the market. Investors need to focus on what a company is worth – independent of the what the market is saying it’s worth. You should be buying when the market is giving you a big discount and selling when it’s paying you a big premium. Prashant Jain, the CIO of HDFC’s Mutual Fund business, said it best in a recent article:

“One year is like one match for us. What’s important is the batting average. One must always look at the future because today’s price is your cost. It does not matter whether I have purchased a stock at Rs 200 or Rs 4,000. If I like a company today, it does not mean the market will like it today. Even if I am right, the market may take two-three years to realise it,”

Basically what he’s saying is that you must always focus on finding value. It doesn’t matter whether a sector or particular stock is in favor with the market. It might take time but eventually, the market will realize the true value of a stock. A good example of this is the IT sector. You can read about my prior calls to “Buy” Infosys ahead of Q3FY13 results and then”Sell” ahead of Q4FY13 results. In addition to my call on Infosys, I’ve recommended two midcap IT players to my Premium Access subscribers, which have strongly outperformed the benchmark indices in the last month. I initially recommended Hexaware back in May 2013, when it was trading in the low 80s range. The stock subsequently declined after my recommendation as the IT sector was out of favor. However, I knew the company had a “narrow moat”, decent growth prospects, compelling valuation and was paying a 6.5% dividend yield. Thus, I maintained my position and the market has come around to my view. Fortunately, it just took a few months but I still think there is upside from here. The chart below shows year-to-date performance for Hexaware (blue line) vs. the Nifty midcap index (red line).

Obviously my paid subscribers will be the first to know when I issue a sell recommendation, if the stock trades above my estimate of fair value. I’m highlighting Hexaware to show that a value investing approach works over the long-term. You don’t need to follow the “half knowledge” guy to make money in the market if you focus on finding intrinsic value. As obvious as it sounds, it’s quite liberating when you actually begin following such a straightforward investing approach. The daily news flow becomes background noise and you are better able to focus on the things that really matter.

Once you’ve accepted this methodology the next logical step is to identify an approach to measure intrinsic value. The three primary methods used by value investors are the net asset value, private market or discounted cash flow approach. I’ll plan to go into more detail about each methodology in future posts since they all have positive and negative qualities. None of the methodologies listed is earth shattering, the important thing is to pick one as your primary tool and follow it rigorously.

P.S.

For those of you who made it this far, I’m going to give you a small reward. I’m now providing access to the May issue of the Premium Access report, where I recommended Hexaware, for all subscribers to the free newsletter. If you haven’t signed up for our free membership, you can use the form below. Once you receive your username and password via e-mail, you can login using the following link and you can access the report via the membership navigation bar on the left side of the screen.

Written by Ankur Shah

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