Philosophical Basis for Value Investing

Value investing is based on that every asset has a value. A good investment occurs when we pay less than the real value of the asset or equity for it. In words of Warren Buffett, “Price is what "Price is what you pay. Value is what you get."

Value Investing vs. Market Efficiency Theory

Market Efficiency Theory says that stock prices fully reflect all available information on a particular stock; hence, it’s impossible to predict a return on a stock price because nobody has access to information not already available to everyone else.

However, this theory is not completely true. I was demonstrated that they are some clear signal which mean than market is inefficient. For example, the fact that many Value Investors, such as Warren Buffett, John Templeton or Joel Greenblatt, could beat the market repeatedly is a good evidence of market inefficiency. I will study this topic more in depth in an upcoming article.

Value Investing vs. “Bigger Fool” Theory

This theory argues that the value of an asset is not important as long as there is a “bigger fool” around willing to buy the asset from them. I know that people can make good profits using this method, but the problem is that is dangerous because there is no guarantee that there will be a “bigger fool” when you want to sell.

A good example of that you can earn a lot of money and that you can lose it with the same ease is the case of Infospace.com. During the dot-com bubble, people could make a lot of money investing on this company with the “Biggest Fool”. The company went public in December 1998 closing at $20. It reached a peak of $1,305 in March 2000. Its share price is currently below $11. Here you can see the graph of its share price.

The company was the same, its fundamentals were the same, but the price fluctuated move by the greedy of big fools who wanted easy money. People lost millions because of using this bubble. However, real intelligent investors did not.

Can we value a company objectively?

Some people might say that value is in the eye of the beholder, but companies are not pieces of art. Value comes from the present value of the future cash flows that the company will generate, so the value of the company is completely objective.

The problem is that we might not know surely the future cash flows that a company will generate. Can we value objectively them? The answer is yes. There are some methods to objectively value companies with this problem, but I tell you more about this topic in forthcoming articles.

This article is also available in Spanish

Este artículo también está disponible en español

Technical Analysis and me

When I started to be interested in the stock market, I only thought in earning a lot of money. After reading a couple of basic manuals in order to know how the stock market works, what I wanted to know was how to earn fast and big money. I wanted to know the secret formula to earn money non-stop, because I thought that people who know how to invest in the stock market earn money continuously. In that moment, technical analysis appeared in my life.

The first book that I read of these characteristics was “Secrets for Profiting in Bull and Bear Markets”, written by Stan Weinstein. He shows his point of view about the stock market since the first moment, as we can see in this paragraph:

“Buy low, sell high! That’s the shortcut to a fortune, right? Wrong! It is just one of many loss-causing clichés that the crowd chants as the lose money year after year”

To be frank, he convinced me completely. All through the book he shows many graphs in which we can see that how investing in the adequate moment and following the bullish trend, we can obtain profitability of over 100% almost without difficulties.

Just after finishing the book, about April 2007, I thought that I could invest successfully. I was convinced of that only looking at the graph I would know what I had to do. I thought that taking into account trends, moving averages, resistances, supports and all that kind of information I could start to earn money without risk and non-stop. After the analysis of many graphs, I found two evident buying opportunities that I can remind perfectly: Mapfre and Banco Popular. I could see myself counting the earnings. Here we can see both graphs.

Mapfre:

Popular:

As you can observe, in both graphs the trend line is clearly bullish. Moreover, in both graph we can see how the price broke the resistance, being a double resistance in the case of Mapfre. It seemed two manifest buying opportunities, at least according to the book that I had read. However, Mapfre’s share price fell from more than €4 to less than €2.5 and Banco Popular’s share price fell from €16 to less than €9. It was a complete disaster.

After these two mistakes, I realize that something was wrong, that my knowledge about the stock exchange was not sufficient, so I decided to read one of the most complete technical analysis books: “Technical Analysis of the Financial Markets” by John J. Murphy. In this book I could learn all related to technical analysis, with which I thought I would be prepared to earn money definitively.

Despite I had advance knowledge about technical analysis, I continued without seeing any profit. Neither trends, nor moving averages, supports, momentum, MACD… Nothing worked in order to forecast future performance of the stock market. My knowledge only was useful to find defects and explanations (always a posteriori) which explained the reasons for my forecasting errors.

Finally, after so many disappointments with technical analysis and so many attempts to become rich quickly trying to forecast the short-term performance of the stock market, I realized that it was almost impossible and, moreover, technical analysis made no sense for me. Perhaps it works for some people; nevertheless, from my point of view, I don’t find it effective and I find it very risky and, over all, lack of the most important thing: a solid basis in which it could be settled.

This article is also available in Spanish

Este artículo también está disponible en español