Value Investing: From Graham to Buffett and Beyond(WileyFinance)KindleEdition by Bruce C. N. Greenwald, Judd Kahn, PaulD.Sonkin, & 1more

You should invest in a company that:

1. has long-term, sustainable competitive advantages in business, and
2. has honest (and good) management, and
3. its stock is left undervalued due to short-term and fixable company issues, a problem within the industry, and/or market disruption as a whole(*).

(*) These are irrelevant to a company's long-term value.

Most importantly, you have to understand its business before investing in it.


Investors should have (1) diligence, (2) honesty, and (3) common sense.


Valuation approaches: (1) asset, (2) earnings, and (3) growth


Warren Buffett:

• Equity Investment Strategy = Evaluate the Business in Its Entirety
• "We want the business to be one (a) that we can understand; (b) with favorable long-term prospects; (c) operated by honest and competent people; and (d) available at a very attractive price."
• Time is the friend of the wonderful business, the enemy of the mediocre.
• An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation. The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage.
• "Investment is most intelligent when it is most businesslike."
• "When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact."

Mario Gabelli:

• Private Market Value (PMV): the value an informed individualist would pay to purchase assets with similar characteristics (*)
• Graham & Dodd + Warren Buffett = GABELLI
• Graham & Dodd
• net-net stocks that are discounted to their book values
• Warren Buffett
• valuing a business's franchise
• taking a substantial stake in portfolio companies
• Gabelli
• Assessing a company's private market value (PMV)
• Identifying a catalyst to surface these underlying values
• Catalysts: An industry or company specific event. For instance,
• a regulatory change,
• industry consolidation,
• a repurchase of shares,
• a sale or spin-off of a division, or
• a change in management
• Valuation methodology
• free cash flow (earnings before interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow the business); (EBITDA - capex)
• earnings per share trends; and
• private market value (PMV), which encompasses on and off balance sheet assets and liabilities
• Gabelli's sell decision is made when
• the securities are selling in the public market at or near Gabelli's estimate of their private market value or
• if the catalyst Gabelli expected to happen fails to materialise
• In summary, "value plus a catalyst" is a winning formula for generating superior returns in any market environment.
• PMV as an investment strategy: three additional features that make it a genuine innovation:
• [1] PMV = intrinsic value + premium for control
• Unlike the passive investor who buys a security and hopes the company exceeds expectations, the industrial buyer is in a position to change the underlying business. He or she can fire incompetent management, dispose of unproductive assets, consolidate the operations with those of another firm, restructure the balance sheet, and do a host of other things to make the assets more productive and swell the cash flow. Because this buyer is probably familiar with the industry, it will not take long to turn things around. Because they can do more with the company than can the passive portfolio investor, they may be willing to pay more for it than the current market price. That extra amount is the premium for control. The payoff for portfolio investors such as Gabelli is that if they can identify firms selling substantially below their PMV, they can buy the shares and capture that control premium when the industrial buyer moves on the company.
• [2] Discovering gaps in GAAP, moving beyond financial data and focusing on operating statistics
• That is, either assets or earnings power that are masked by genially accepted accounting principles (GAAP) and thus not revealed in standard financial statements. Some of these may be the old standbys: assets not reported at all on the balance sheet or carried at cost rather than current market value; operating income not disclosed on the profit and loss statement thanks to some unusual financial structure or the consolidation of profitable divisions with those that are losing money. Certainly, the industrial buyer will not be blind to these values.
• Knowing the number (of subscribers for the communications business, cable and broadcast television companies, radio operators, and magazine and news paper publishers) helps the financial analyst compare the performance of different firms in the same industry: what their revenues or operating earnings per subscriber are. It also permits the analyst, on the basis of recent sales of firms within the industry, to see how much the industrial buyer was willing to pay per subscriber.
• [3] Catalyst
  • Recognition that it takes something—an event, a person, a change in perception—to narrow the spread between the market price and PMV. All investment strategies require a catalyst to make them pay off. Value investors in general, and PMV investors in particular, would prefer not to rely on such an amorphous and fickle instrument.
  • Two kinds of catalysts
  • Specific
  • Those changes, either anticipated or recently occurring, that alter the prospects of a particular company. The grimly labeled “death watch” stocks are attractive to investors who believe that the departure of the CEO or a large shareholder will allow the company, once freed from restraints, either to improve its performance or to restructure itself, including here selling the whole thing.
  • The slower-than-anticipated upfolding of the catalyst resulted in a somewhat lower annualised return on his investment.
  • Other company-specific catalysts include all types of financial or operational restructuring, such as the spin-off of a division or a significant repurchase of shares, a change in management, and investments in new business developments.
  • Changes like these stir the pot and reward investors who understand the company and can see, before the market, that improved earnings are on the way.
  • Environmental
  • Disruptive shifts in the world in which business operate. We refer not only to global warming, which is obviously an environmental catalyst however one uses the term, but to changes in the political, social, and economic climates as well. e.g., the destruction of the Berlin Wall in 1989
  • In many instances, the environment in question is the government, in its legislative (i.e., laws), administrative (i.e., monetary policy, fiscal policy, and contracting standards), and regulatory roles (i.e., regulations and tax rulings).
  • Other environmental catalysts emerge as the consequences of disruptive shifts in technology that facilitate the reorganisation of whole industries. The most unavoidable one in our time is the Internet and al the related changes that flow from breaching the protective barriers of time and space.
  • Consolidation is one result of many of these environmental catalysts.
  • For Gabelli, prepared with techniques for appraising PMV and adept at spotting catalysts, it is a heady time.
  • It does try to identify large-scale trends—economic, demographic, political, or cultural—that will help or impede the earnings of the company moving forward.
• Capitalisation rate = (Operating cash flow) / (Enterprise value); pretax earnings on the entire investment

(*) For more details about PMV:
http://www.gabelli.com/news/articles/reg-selby_123099.html


Glenn Greenberg:

• Investigate, concentrate, and—watch that basket, rather than scattering your money and attention.
• Investigate
• It is far more important to select the proper eggs to put into that basket than to watch them once they have been chosen. Greenberg attributes a great deal of his success to the firm’s approach to finding the right stocks.
• Concentrate
• Under the rules they established for themselves, the Chieftain partners will not bing to buy a stock unless they are willing to put at least 5 percent of their assets into it. This is an anti-diversification device, and it has a manifold influence on their entire investment process.
• First, they need to have two types of confidence in the selection: (1) confidence in their ability to understand the company, its industry, and its business prospects; and (2) confidence in the company, that it will continue to perform well and increase the wealth of its shareholders.
• Greenberg doesn’t even start his purchasing until he has done most of the research that will make him an expert in the company. Obviously, there is always more to learn, and in the time that he holds the stock, which can be years, his knowledge and understanding deepen and broaden.
• To improve their odds, all four professionals in the firm study the same stocks, and they have to agree before they buy a share. If diversification is a substitute for knowledge, then information and understanding should work in reverse.
• Buy good companies (and watch the basket)
• Buy "good" businesses, by which they mean those that are unchallenged by new entrants, have growing earnings, are not vulnerable to being technologically undermined, and can generate enough free cash flow on a regular basis to make the shareholders happy, either through dividends, share repurchase, or intelligent reinvestment.
• Current managers are healthy and young enough to keep the company on course for a few more years.
• Buy Them Cheap

Robert H. Heilbronn:

• Heilbronn’s innovation was to focus on the variability of a single stock as it is traded within its historic ranges, identifying its highs and lows as compared with itself. (e.g., P/E ratios)

Seth Klarman:

• The two oldest investment rules: (1) Don’t lose money, (2) Don’t forget the first rule.
• Value investing was the only strategy that took care to limit risk while still holding out the prospect for attractive returns over time.
• Evaluate risk (the likelihood and magnitude of possible losses) first.
• Motivated seller is selling for a noneconomic reason. e.g., An index fund’s charter—own only the securities in the index
• Missing buyers due to small size, no coverage (spin-offs), or distressed debt (bankruptcy or the threat of it); these also apply to motivated sellers' case.
• Find situations in which the overall market plays little or no role in the timing and amount of return. e.g., distressed debt especially in the bonds of companies in default, liquidations, and takeovers.

Michael Price:

• A goal frequently invoked is to match the market when it is going up but to decline less when it is going down.
• Portfolio
• Two thirds: cheap stocks
• One third: divided as opportunity dictated among bankruptcy plays, arbitrage positions, and cash, with the cash never falling below 5 percent of the portfolio.

• Price's approach to investing
• Discipline: Don't deviate from the valuation standards, especially as the sirens of momentum are enticing the unwary. Also, don't alter the policy you have established for the compositon of the portfolio just because other approaches are currently more favored.   
• Patience: After the analysis has been completed and the intrinsic value is determined, don't chase the stock. It is important to wait for the market to offer a price with a discount large enough to allow for a margin of safety. (Patience is certainly a virtue for investors, but so is alacrity when the situation demands.)
• Focus: Don't be distracted by global predictions or macro forecasts. It is much easier to understand a security than an economy, and the way to profit is by using that understanding.
• Do-your-homework: Each investment is a wager against the party on the other side of the trade. Only one of you will be right, and the prize usually goes to the person who knows more about the security and knows it sooner.

Walter and Edwin Schloss:

• Modern investment theory argues that return is compensation for risk, that higher returns are achieved only by increasing the volatility of the portfolio. The investment success of the Schlosses does not confirm the theory.
• Focus almost exclusively on the published financial statements that public firms must produce each quarter.

Paul D. Sonkin:

• Cap Rate = (EBIT)(1 - tax rate) / (MVDebt + MVEquity - Cash&Cash equivalent)
• The cap rate analysis is a starting point for Sonkin, a kind of screening test to see if the company merits further work. The purpose is to expose what a (debt & equity) investor would have to pay to own all the after-tax operating earnings of the company.
• It is a truism that though all value investors are contrarians, not all contrarians are value investors. Value investors want to compare the current price of the securities not simply to its former high—all that means is that some investors are deeply disappointed—but to the intrinsic value of the firm, which means examining the assets and the earnings power.
• Small stocks:
• are better growth prospects than those the are already large (more nimble to take advantage of new opportunities or changes in markets),
• may be a bargain because many funds are prohibited from owning them, 
• have less coverage, and
• are much easier to understand.

Value Investing: From Graham to Buffett and Beyond (Wiley Finance) Kindle Edition

by Bruce C. N. Greenwald, Judd Kahn, Paul D. Sonkin, & 1 more

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