It is very easy to call oneself a value investor but actually being one is harder. A value investor is someone who will buy stocks which are trading under their intrinsic value and then sell them at a profit once the markets makes the stock overpriced.
When I started investing, I used to value companies based solely on multiples such as PE ratio and PB ratio. The problem with that it is too dependent on the market, on Mr Market. Warren Buffett says that we should not focus on what the market values the company but the business fundamentals.
Warren Buffett says that the intrinsic value of a company is its total discounted owner's earnings through judgement day. The owner's earnings is pretty similar to the free cash flow. So in other words, Warren Buffett values a company based on the total amount of cash that it can generate to shareholders through infinity. Since cash today has more power than cash in the future, we need to discount these cash flows at the proper rate. That's how I am currently valuing companies, a variation of the DCF model.
But the DCF model (Discounted Free cash flow model) has limitations. It only makes sense if you're going to hold the company forever. If you're not going to hold the company after 20 years, why do you need to discount its owner's earnings from then. The DCF model is also very sensitive to changes in the discount rate and rate of growth of the terminal value.
A better way to value companies is to use a combination of DCF model and valuation multiples. For example, you can estimate the free cash flow in 5 years then make a bear, base and bull case of the possible valuations of that company in 5 years based on the possible free cash flows.
Another thing that I have to work on is in my analysis, making my analysis more professional. I can certainly improve in my presentations. They need to be more concrete and more accurate.
Every assumption and every estimation needs a reason why.
Another improvement as a value investor is to focus on my circle of competence. Instead of me analyzing 1000 companies to only invest in 10. It is better to analyze 100 and invest in 10. Most companies don't deserve my time. Warren Buffett said in a recent interview that he doesn't need to have an opinion on every company. That's something that every value investor needs to apply. Only focus on your circle of competence.
As an investor, you always needs to improve. Today, I am a better investor than I was 3 years ago and 3 years from now, I will be a better investor than I am today. That's why Warren Buffett reads 500 pages a day. He is still learning. When he was managing the Buffett partnership in his 30s, he had a different style of investing compared to today. But the principle of value investing is the same.
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