"Investing" - a perspective

So what is Investing ?

For the sake of providing a definition, here is the simplest one that I have come across so far:

"Investing is putting out money to be sure of getting back more money later and at an appropriate rate"

Yes Yes ... I hear you… I agree it's a very simple and generic definition.... but that's the way it is…

Investing, as I understand is a lot about "Perspective"
(what feels like "gold" in the hands of one, could feel like a "mine" to someone else)
Trying to generalize Investing by your taste/understanding and mixing perspectives may not always result in a "goldmine", so to say...

On a more serious note this time….

How do you make Investment decisions ?
How do you decide whether a deal available in the market is good ?

Answer: By comparing the 'Price' and the 'Value'

Price: How much is it selling for ? (Market)
Value: How much do you think it is worth ? (Intrinsic)

That's All!
While the Price is offered by the Markets, you need to find the Value on your own.
The trick however is that there is no Universal Value and there is no correct or incorrect value…
This means neither will searching Google help you "find" the value, nor will using Bing help you "decide" the value…

Now the question is, how do I then arrive at the Value ?

What differentiates Investors from each other [other than 'Perspective' and 'Composure (including emotional)] is how they 'Evaluate'…
This is the single reason 'why Investors are not commoditized' and 'why Investing is not automated' …. :)

Now for Valuing, you may use any data/approach you like from studying business models, to strategy, balance sheet, cash flow, free cash flow, dividends or dividend yields, brand value, patents, culture, promoters, employees, RoE, moat, book value, sales and profitability, growth in business, profitability or holdings, study the sector or economy, correlate it with macro economic factors like GDP, liquidity, unemployment rates, bank interest rates, bond yields…….and on and on and on from business to business.

You have your freedom to approach it the way you like…but more importantly, do it yourself and know what you are doing...

(Perhaps, I will talk more about my way of valuing companies in a separate blog later)

One interesting dimension to valuation is:
Value of something today versus Value of something in the future (as expected/projected/estimated) …. i.e.: 5 or 10 years thereafter
[This dimension builds the foundation for long term investing! ]

However, you do not arrive at the value by asking friends or reading recommendations or listening to analysts or looking at the stock price or the historic stock price range…..

Three common mistakes Investors make with Investing/Valuing

1. Depending on other people's recommendation or valuation (most often: analysts, articles and friends)
Two reasons why you must do your homework yourself:

1. There is neither going to be an "understanding" of it nor any "learning" from it unless you do your homework yourself
   (And more that anything else, Investing is about experimenting, learning and growing as an Investor)
   "Give a man a fish, and he’ll eat for a day. Teach a man to fish and he’ll eat for the rest of his life"
2. Who do you blame when you lose money ?

2. Using the Price Tag to find the value of a productThis is as funny and as stupid as it can get! Yet over 99% investors are unable to escape from this temptation!
Look at the business first, see how much it is worth, then look at the market price and see if it looks attractive.
If you look at the price first, you are bound to get influenced by it ….and your Value of the business may tend to confirm to or towards the Price…
Again, the relatively smarter ones should know that seeing the range of the Tag price for last 52 weeks is also not going to tell you the Value….
Remember that the best opportunities for investment are the ones where Price and Value are farthest apart (leave aside growth for now)

I for one apply the same approach to bargaining and find it awfully interesting to observe people when they negotiate… :)
(I will in fact write a separate post on my approach to "bargaining" some time … :))

3. Bottom-Up instead of Top-Down
I believe the way to study and value a business is top-down.
You look at the business in totality, look at its existing and potential market, looks at revenues, profits, cash flow, assets, debt etc, then come up with a value that you think it is worth(or what would you be willing to pay to buy the whole business) and compare it with its current market cap.
You can now divide your value of business by equity of the business to find how much you would be willing to pay for a % ownership in the company by buying shares.

I have seen a lot of Investors, specially retail investors go lost in per share data(Earnings per share, Dividend per share, blah blah blah)….
Many have argued with me as to what is wrong with their approach.

There are two issues that I see with this:

1. In most cases, I have seen that people's bottom-up approach does not scale all the way to the top. I can bet that more than 90% retail investors do not know either or all of Market Cap, Annual Sales and Earnings of the businesses that they have invested in.
   On the least, have you ever done the exercise of multiplying your per share figures with total equity of the company to see how big your company is…
   Many may still not get the point. While some may actually laugh wondering "Do you really want to buy the whole company and Do you have so much money!"
2. How do you expect to evaluate market potential of a company ?
   Funny, as I haven’t heard anyone start from thinking that XYZ company has the potential to make revenues of ABC per share
   "A man has $1 million in wealth. He has decided to distribute it equally among all his employees. Being one of his employees, you are certainly excited, but can you tell me what would be your share of his wealth without knowing how many employees he has ?" For employees such as these, I wish that the man has at least a million employees :)

Traders and Brokers excused, but if you intended to be an Investor, remember that 'Stocks are but just a medium to Invest in a Business…'
Investing is not about buying some stocks and refreshing the stock price every 5 minutes to track the health and performance of your business :)

If you cannot tell the value of something (how much should it be worth) and yet decide to own it, how would you ever know if you paid the right price, and how would you ever know it is the time to sell...
"It is like getting into a debate or an argument without having an opinion"
Can there be Investors without a Perspective (or an Investment philosophy) and without a Value for their businesses in mind?

Leaving product, service or need based Markets aside and talking about stock markets…..

If you come to think if it, the very foundation of Markets is based on the differences in Opinions and Perspectives
Every time someone is buying a stock, someone else is selling it
(Under all normal circumstances, Every single trade/transaction reflects contradiction in what 2 people/parties believe)

Alternatively, If everyone thought alike, there would be no transactions :) [Under all normal circumstances]

A lot of questions start getting answered as you take eyes and time off the stock prices and start wondering why Markets were created...
(I will leave the exercise to you as this questions is best unanswered)

Coming back to Valuing, Investing and Markets:
For most part, you make money by going against the market.
You buy or sell when you are convinced that the price offered by the markets does not reflect the true value or potential ...

On a closing note
Use markets as a tool for Investing, exploit and take advantage of them when they seem irrational… But more friendly you get with markets and more you start gossiping, singing and dancing together, less are the chances that you would find more compelling opportunities…under the influence of your friend...

I recommend reading Mr. Ben Grahams theory on Mr. Market !