Value Investing: The Art of Buying Undervalued Companies

11 minutes

 

“Price is what you pay, value is what you get.”

Warren Buffett

In this simple saying, Warren Buffett, arguably the greatest investor of our generation has summed up what value investing is. It is the search for companies that are selling below their intrinsic value, with the hope that we can buy them at a discount and that their price will rise over time.

Value investing, unlike some other investing strategies is fairly simple. It doesn’t require that you have an extensive background in finance. Certainly, understanding the basics of finance will help, but you don’t need to go to Harvard to follow this strategy.

It also doesn’t require an expensive subscription to terminals to help you find companies or how to read very extensive charts. There is also little need for math, but some is required.

The main ingredients needed are patience, common sense, money to invest and the willingness to do some reading and accounting then you have what it takes to become a value investor.

Five Fundamental Concepts of Value Investing

Value Investing Fundamental No. 1 – All companies have intrinsic value. This is what gets most people about value investing. The basic concept is so simple that you probably do it on a daily basis already. The idea is that if you already know the true value of something then you will save a ton of money by buying it when it is on sale.

Let’s use an example to illustrate. Most people would agree that whether you buy a new cell phone when it’s on sale or when it’s at full price, you’re getting the same cell phone with the same screen size and same memory. The obvious assumption that we have to make is that the value of the cell phone will not depreciate with time as new technology becomes available.  

Stocks are the same way, the company’s stock price can change even though it’s intrinsic value has stayed the same. Stocks, like cell phones, go through periods of higher or lower demand. These fluctuations change the price but they don’t change what you are getting.

Most savvy shoppers would say that it is crazy to buy a cell phone at full price when you can buy them on sale many times throughout the year, particularly during the holidays. Stocks work the same way. The only difference is that unlike cell phones, there is no predictable time of the year that stocks will go on sale, such as a Black Friday event. Which is unfortunate. Also, their prices won’t be advertised in a daily mailing like Target. Also unfortunate.

If they did know about the sale price it would create more demand and drive up the price, which means they wouldn’t be a bargain for us to take advantage of.

The trick with value investing, if you are willing to do a little sleuthing work to find these secret sales, you can get stocks at a discount that other investors would be oblivious to.

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Superinvestors of Graham and Doddsville: What We Learned

13 minutes


picture courtesy of ruleoneinvesting.com

“While they differ greatly in style, these investors are, mentally, always buying the business, not the stock. A few of them sometimes buy whole businesses, far more often they simply buy small pieces of the business.”  

        Warren Buffett, Superinvestors of Graham and Doddsville

In May 1984, Buffett laid out his thoughts on everything you need to know about his investing philosophy.

In a speech at Columbia Business School, which was later adapted into an essay. Buffett introduced what he termed “The Superinvestors of Graham and Doddsville.”

The “Superinvestors of Graham and Doddsville” is a name that Buffett gave to Benjamin Graham and a group of his proteges. The group of money managers once studied under or worked for Graham, Buffett or Munger, Buffett’s partner at Berkshire Hathaway. We will talk about each of them more in depth coming up.

The speech was given in honor of the 50th anniversary of “Security Analysis” which was written by Benjamin Graham and David Dodd. The book was published in 1934 and was the seminal book on analysis business using financial fundamentals that were outlined by Graham and Dodd.

Warren Buffett is arguably the world’s great investor, there have been many books, essays, and papers written on his greatness. I am not smart enough or eloquent enough to improve on them but I will touch on his beginnings for a moment.

Although Buffett’s father was a stock broker he didn’t have his a-ha moment until he read another very famous Graham book “The Intelligent Investor”. It caused Buffett to apply to the Columbia School of Business to study with Graham. To this day, Buffett credits that book with changing his professional life and Warren believes that most of what everybody needs to know about investing come from two chapters in the book.

The chapter on Mr. Market, which outlines behavioral finance concepts before the term even existed. And the chapter on Margin of Safety.

Breakdown of the speech

At the start of the speech he asks the question “is the Graham and Dodd look for values with a significant margin of safety relative to prices approach to security analysis out of date?”

He then touches on the theory of Efficient Market Hypothesis, which states that the market is efficient in how it prices each and every stock in the market. Meaning that the market is taking into account everything that is known about the company’s prospects and the state of the economy in the price of each stock.

The hypothesis states there are no undervalued stocks because there are smart security analysts who utilize all available information to ensure unfailingly accurate pricing.  

He thinks that this is bunk!

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403b: 9 Benefits that Can Help Your Retirement Savings Grow

9 minutes

photo courtesy of borderlessreviewsandnews.com

What is a 403b?

A 403b plan is a retirement plan for certain public school individuals, employees of tax-exempt organizations, and ministers. Individual 403b accounts are set up by employees and managed by eligible employees.

While not as prominent as the better-known 401k, the 403b retirement framework is often used by schools systems, churches, hospitals and may other types of organizations.

The structure of the 403b is as follows.

An individual account within the 403b typically takes the form of a Tax Sheltered Annuity. This is an annuity contract offered by an insurance company. In exchange for a premium, which can be paid in a lump sum or a series of payments. The insurance company agrees to make fixed or variable payments beginning at a future date. This can be either for a specific term or for the rest of your life.

Like a pension, your contributions and your contract’s earnings from investments can consider building up your retirement income stream.

A 403b can also be structured as a custodial account that can invest in mutual funds.

Some 403b plans which are specific to churches can take the form of an account that invests in either mutual funds or annuity contracts.

You can’t contribute directly to your 403b plan. What they do instead is per your salary-reduction agreement they withhold a predetermined amount from your paycheck. This is known as an “elective deferral”. These elective deferrals are exempt from income tax, although you are still responsible for Medicare and Social Security tax on these contributions.

Plan earnings are also exempt from income tax until the participant withdraws them. This is one of the big benefits of the 403b plan and the tax-deferred annuity structure.

One thing to keep in mind is that some plans don’t allow for after-tax elective deferrals. In these cases, the deferral amounts aren’t deductible on your tax returns. Of course.

On top of elective deferrals, your employer can contribute directly to your plan via “non-elective contributions”. Current regulations allow your account to be funded through a combination of elective deferrals and employer contributions.

So how much can I contribute to my 403b?

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3 Different Types of Annuities and How They Can Be of Benefit

12 minutes

 

Photo courtesy of clay marketing

Did you know that Charles Dickens refers to annuities in his novels often because they were the favored investment of the upper class in 18th century Europe?

Or did you know that Babe Ruth didn’t lose his money during the Great Depression because his money was safely invested in annuities?

One last one for you. Did you know that Wheel of Fortune often gives away annuities as prizes?

Annuities are a product that most of us have heard of, but what do we really know about them? What are they really? How do they work and when should I use them?

These are some of the questions we will answer as well as looking at the different types of annuities, and there are many.

What are Annuities?

Annuities were invented by Babylonian landlords in approximately 1700 BC. They used the income from a certain piece of farmland to provide lifetime rewards for soldiers loyal assistants.

In more recent times, annuities were first offered to the American public in 1912 by the Pennsylvania Company for Insurance on Lives and Granting Annuities.

According to Investopedia, an “annuity is a contractual financial product sold by financial institutions that are designed to accept and grow funds from an individual and then, upon annualization, pay out a stream of payments to the individual at a later point in time. The period of time when an annuity is being funded and before payments begin is referred to as the accumulation phase. Once payments begin, the contract is the annuitization phase.”

Annuities were designed to be a reliable source of steady cash flows for an individual in their retirement years. Or alleviate risk or the fear of outliving your money. A very real fear.

Annuities can also be created to turn a large lump sum of cash into a steady cash flow. This is great for winners of large sums of cash such as lottery winners or a winning a lawsuit.

Defined benefit pensions or Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass.

You remember those J.G. Wentworth commercials? Well, those are the perfect example of a lifetime guaranteed annuity. You give them your lump sum of cash and they give you a lifetime cash flow for that exchange.

How do Annuities Work?

An annuity is a cross between an insurance product and an investment product. They come in many different shapes and sizes, but the basic theme is that you give your money to a financial institution, like an insurance company and they promise you a certain rate of return, usually for the rest of your life.

The annuity will make payments to you on either a future date or series of dates determined by you. The income you receive from an annuity can be paid out monthly, annually, or even a lump sum payment. Continue reading “3 Different Types of Annuities and How They Can Be of Benefit”