The Hard Knock Life of a Value Investor

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There have been a number of academic studies that outline the outperformance of a value based investing approach relative to a growth based one. However, the purpose of this post isn’t to delve into those studies, but to discuss the psychological barriers that makes following a value based investment approach difficult. Fundamentally, value investing is about buying a business at a price that is below its intrinsic value. The rub so to speak is determining what is intrinsic value. This differs greatly from the typical DCF discounted cash flow approach used by Wall Street and large institutional investors. The point of the DCF is to project years out into the future revenue and profitability and then to discount those values back to the present to determine whether a company’s shares are undervalued. Value investing on the other hand places less emphasis on forecasting and more on tangible value such as whether a company is trading below its net asset value. Although superficially this appears easy and almost effortless. But I think the true challenge is not the analysis but controlling your emotions and above all and staying patient in order to truly find undervalued gems. I think there are two main psychological barriers that prevent people from being successful investors. The need for immediate gratification and the pain of inaction. Obviously, anyone would prefer to make a quick trade today for significant gains rather than waiting for a longer-term investment to play out. Unfortunately, value investing is not a get-rich-quick scheme. In many cases it takes 3 to 5 years for a investment theme to play out. That’s a long time to wait if you’re looking to make a quick killing in the markets. I think successful value investors are not necessarily smarter they are just better suited mentally to wait for the right opportunity. As we’ve seen in many cases it takes a long time for the market to revalue a stock. As humans, I think it’s the things we don’t do that cause the most regret as opposed to the changes or actions we took. Sometimes just being patient and waiting for an investment thesis to play out takes time. If you’ve already made an investment and it’s not performing well while the market takes off it may be difficult to sit and wait for the intrinsic value of your investment to materialize. I think value based investing continues to outperform the market and continues to prove the efficient market hypothesis wrong because human nature doesn’t change. We’ll always prefer the quick payout over the long arduous slog and we’ll always feel like sitting and waiting is not the best use of our time. I think that’s why Warren Buffett has never been concerned about value investing becoming so popular that it reduces his ability to find good investments. Human nature is not going to change so there will always be individuals who have the requisite patience and mindset to become successful value investors.

At this point you might be wondering why I haven’t spoken about any particular Indian stocks. My goal for this site is to not solely provide investment ideas but to also make the case for a value investing based approach. I also think that despite the recent correction there aren’t any truly interesting investments in the Indian market. However, I continue to screen for new investment ideas and will only discuss high conviction ideas that I think will make money even if there is a future correction in the Sensex. As I mentioned a value investor must learn to be patient before anything else.

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