Connect with us

Investing

Value Investing – Are Cheap Stocks Always Great Companies To Invest In?

A cheap stock doesn’t equate into a valuable stock.

 

“Price is what you pay, value is what you get” – Warren Buffet

This often mentioned quote from Warren Buffet, perhaps the most famous investor of all time, is frequently used to describe what Value Investing is. The idea behind it is that the amount investors pay for a stock does not necessary translate into the equivalent value he or she receives.

Value investing is a strategy where investors seek to identify and invest into companies they believe are undervalued in the market. The belief behind value investing is that not all companies are accurately priced in the stock market, and some companies offer far better investment prospects than others.

To better understand the process of value investing, we spoke to the founders of ASX (Australian Securities Exchange) listed 8I Holdings Limited, Ken Chee and Clive Tan. 8I Holdings Limited is the Group behind 8I Education, a company that specialises in educating people about value investing.

Is Value Investing Like Picking Out Gems At A Flea Market?

A simple analogy for value investing is that of a shopper visiting the flea market. We know that there will be some junk on sale at the flea market that simply isn’t worth buying and other goods that are really nice but are too expensive, but we still go hoping to find great deals and uncover hidden gems.

In this aspect, value investing can be thought of as similar. We can scour the stock market to find those that we believe are cheap, and determine which stocks we think will deliver the best returns.

Unlike index investors who are not concerned about the performances or prices of individual stocks because they invest into the market as a whole, choosing the right stocks is vital for value investors.

Read Also: Value Investing Or Index Investing? Which Is The Better Investment Approach?

“Go Beyond The Flea Market”

Ken, founder of 8I Education and Executive Chairman of 8I Holdings, thinks about it one step ahead. His idea is to “go beyond the flea market” to find good deals.

The challenge, as Ken rightly pointed out, is that it’s not easy to identify good deals at the flea market. The flea market analogy also gives investors the incorrect impression that only “bargain stocks” can turn out to be good deals. That is not true.

Ken shared that the philosophy for a more refined approach behind value investing will be to uncover great companies whose stocks would be able to provide strong investment returns in the long run, without worrying so much about whether the initial price is cheap or expensive.

Using the analogy of shopping for shoes, he draws the parallel between going to a flea market and a branded store to shop for sneakers.

At the flea market, there would be lots of sneakers to choose from. Most buyers will look for the nicest pairs and purchase a few sneakers in order to “diversify” their collections. Individually, he pays less for each pair of sneakers. But the diversification does not guarantee him an outcome of being able to own even one or two valuable sneakers.

In contrast, a buyer may enter a branded store to purchase sneakers. He may find a pair of limited edition Air Jordans and rightfully believe that it’s a valuable purchase. The investor would most likely have to pay a higher price, but the sneakers would be worth the money because of its long-term value.

In the same way, investors should look at the places where valuable stocks can be found, rather than to solely focus on cheap stocks. If a valuable stock happens to be cheap, great! But the idea behind value investing is that long-term value is the primary reason for any investment decision.

Do I Need To Diversify My Portfolio For Value Investing?

One of the basic strategies of investing is to have a diversified portfolio. Because of this, some people prefer index investing. So, should value investors also diversify? Ken believes the answer would be both a “yes” and a “no”.

Diversifying allows one to ensure that “all his eggs are not in one basket”. That’s a smart strategy since we are investors, not entrepreneurs.

However, the extent of diversification depends on your value investing strategy.

For those who rely on desktop research alone, Ken believes that it’s prudent to diversify across approximately 20 stocks. This diversification allows investors to make up for the limitation of desktop research, which may not always give you a complete picture of the company’s performance and its future growth.

For investors who tend to look more deeply into companies within their portfolio, the extent of diversification may not be as much. Such investors will focus more on knowing the management of the company, the industry they operate in as well as growth opportunities for the company.

When Should I Sell My Investments?

A common question asked is when investors should sell their investment holdings. Co founder and Executive Director of 8I Holdings, Clive Tan believes this is not as important a question as what many people make it out to be.

He shared with us something he regularly tells people attending his 8I Education progammes, “it’s not easy to find companies with good profitable businesses. Hence, there is no reason why an investor would want to sell an investment that has done well simply to take quick profits when its price starts increasing. By doing so, investors are in fact setting a limit to the amount they can earn instead of just letting a good investment slowly pan out.

The concept here is to to let your profits run when your investment decisions are right and cut your losses quick when you make wrong decisions.. Instead of worrying over what price to sell, or if the stock would hit its target price, investors should worry more about what to invest in the first place, and whether the growth for the business is still strong as time goes on and the business environment evolves.

If you do want to take some interim profit in order to overcome the psychological barrier of knowing you have realised some profits, Ken suggests one way to do so would be to sell a part of your stock holdings to recover your initial investment capital. This way, the remaining stocks you have left would technically be “risk-free”.

Value Should Be Independent To Price

In our everyday life, we get used to equating value of an object with the price we pay for it. For example, we think a $200 pair of jeans would be “better” than one that costs $90. Or that a sushi platter that costs $40 would taste a lot “nicer” than one at $20.

Unlike consumer goods however, where the stakes are low and the only downside you suffer from a poor decision is overpaying for a meal, investing in stocks has much bigger long-term implication on your financial health status.

As such, it’s important to educate yourself over what you are doing when it comes to value investing, and to make good investment decisions based on informed analysis that you have done.

This article was written in collaboration with 8I Holdings. All views expressed in the article are the independent opinion of DollarsAndSense.sg

About Clive Tan

Clive Tan started his career as a secondary school educator in Singapore. While teaching, the concept of value investing caught his attention and ignited his interest in investments. Within five years his investments enabled him to acquire a struggling childcare franchise and turn it into a highly profitable business, before selling it for a profit.

Clive Tan and Ken Chee identified a strong need in the Singaporean market for education in value investing in 2008 financial crisis, leading to the formation of 8I Education, which is now a part of ASX-listed 8I Holdings Limited (8IH). As a speaker and trainer, Clive has touched the lives of more than 10,000 individuals through numerous educational programs, engagements and at their annual Value Investing Summit – the region’s largest conference for value investing.

Clive is involved in the 8IH’s strategic planning, development and risk management, corporate policies and managing the group’s human capital.

About Ken Chee

Ken Chee is the co-founder of the 8I Holdings Limited (ASX: 8IH) and its subsidiaries. An entrepreneur at heart, Ken Chee co-founded 8 Investment in the height of the Lehman Brothers crisis with the sole mission to create sustainable value through investments, business, and education.

Within six years, Ken transformed 8 Investment from a private investment business with zero start-up capital, into a public-listed company 8I Holdings Limited (8IH) with a market capitalisation of A$250M in 2016. Today, 8IH and its subsidiaries is a leading investment and education organisation, enriching the lives of countless individuals and empowering their growth financially, emotionally & mentally.

In 2005, Ken received the Spirit of Enterprise, Honoree Award to for his contribution to entrepreneurship.