Value Investing


What is Value Investing


Benjamin Graham described it as buying a dollar bill for 50 cents. In reality, any company’s value can be calculated. The number may not be a 100% accurate representation of its intrinsic value, but it can be a good rough measure. A business might own a warehouse appraised at R50 million, the working machinery inside could be worth another R10 million, and perhaps the company bank account has a R5 million positive balance. That would give you R65 million in total assets. On the liabilities side, that same company may have an existing long-term loan owed to the bank of R10 million and another R5 million in outstanding payments still payable to suppliers. That means R15 million of total liabilities.


To calculate a traditional intrinsic value for the company, just subtract the total liabilities from the total assets. R65 million minus R15 million, gives you an intrinsic value of R50 million for the company. This value calculation is called the company’s net asset value (NAV) or its book value (BV). If someone offers to sell you that business for R100 million, you might refuse because it’s way above the NAV/BV. If someone offers it to you at R25 million, you’d be interested because you’re getting R50 million worth of assets in return for your R25 million.


Every JSE-listed company publishes a regular balance sheet with their total assets and total liabilities, and they also have a total market capitalization (or market cap), which is the price the entire company is currently selling for in the stock market. Research from the United States shows a portfolio of deeply undervalued NAV or BV stocks from 1968 to 2008 (a forty year timeframe), returned 19.8% annually – well above what an investor would’ve earned from an S&P500 index fund. The same holds true in various countries, including South Africa. NAV or BV data for the years between 2000 and 2008, show an annually-rebalanced portfolio of the most undervalued JSE stocks returned a compounded annual growth rate of 25%+ over that period.


Another valuation measure compares the after-tax earnings of a company to its market cap. If a company has a R500 million market cap and earned R100 million after-tax last year, then by dividing that R100 million by the R500 million you get a 20% earnings yield. Compared to leaving your money in the bank where you might only earn 5% in a call account, or buying South African government bonds which yield around 8%, you might prefer to own the stock of a company that is generating a 20% earnings yield for its shareholders. So that’s a metric we also use at Deep Value Portfolios.


Price-to-NAV (or price-to-BV) and earnings yield are historically the more traditional tools used by value investors to uncover bargains in the market. At Deep Value Portfolios, we construct our portfolios largely using these metrics in order to ensure we’re buying many of the most undervalued stocks currently trading on the JSE. We also use further tools in order to make sure the stocks we select have enough trading volume, financial liquidity, a low risk of bankruptcy, and so on. These tools add the potential for a few more percentage points of gain on any given portfolio.


One word of caution – on average, 2.5 years of every decade see negative returns. The distribution is random, so you can’t predict when they’ll appear. If you want to earn 15%+ annual returns over a decade, the price of that is occasionally accepting years when your portfolio is down 25%+. Before embarking on a 10 or 20 year investing expedition, first ask if you have the mental fortitude to accept the down years. If you’re the type with a patient discipline who perseveres, you can earn great rewards. If not, you won’t. It really is that simple.


Keep in mind that the links, insights, portfolios, and more, in our letters are provided for educational purposes. None of our content should be considered investment advice or a solicitation to buy/sell securities. We’re an informational newsletter service providing our own personal opinions and materials, so contact an investment advisor before making any financial decisions. For more on this, refer to the disclaimer at the bottom of this website. Please invest responsibly.


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