What to Invest In - Look Around You!

Hi All,

For those that saw my introduction post, you will know one of my roles here at Pynk is to bridge the gap between the Investment Committee and this incredible community.

Here at Pynk we use multiple investment disciplines, and as part of our mission to enlighten Pynksters to embrace and develop their own investment ideas and approach, this week we are focusing on an interesting angle in equities investing.

Isn’t successful investing just about numbers? Don’t you just have to look at a bunch of investment ratios and numbers to find the ‘cheap’ stocks that will go up? The answer is yes and no…… but, actually, mostly no!

A lot of people think if you buy shares when the price is pennies, then you’ve got a really good chance of making meaningful returns. More formally, finding and buying cheap shares is known as ‘value investing’. The simple argument goes that the price of a ‘value’ share is so low that the worst-case scenario is already priced in. A small improvement in expectations of future profits can see big share price gains.

Catching a falling knife?

Mohnish Pabrai, a modern-day value investor sums this situation up nicely when he describes it as like tossing a coin with two outcomes of “heads I win and tails I don’t lose much”. This makes sense: usually no one is expecting much from these cheap companies so it seems plausible that not much can go wrong. But the problem is that whatever has gone wrong with the business so far to make them cheap, (eg in the case of Debenhams, a UK retail chain, shares were falling because consumers preferred other stores or online shopping), can continue to adversely affect them. Blindly buying cheap stocks doesn’t always pay off as many cheap shares have become cheap for a good reason. They are often struggling businesses with uncertain futures. Looking at this another way, you could argue that the price of the share has to be very cheap as investors are being asked to put their money in a risky situation with less than great prospects.

Having said all that, sometimes there are new good reasons why things are likely to pick up compared to the past. Formally, this is known as when there is a ‘catalyst’ to value creation. Company prospects might be starting to change for the better and therefore the share price can justifiably rebound and often quite strongly. In order to avoid catching a falling knife, we want to be sure things have improved for the company before deciding the shares should be worth more.

P/E? PEG? FCF? P/S?

These terms can seem a little complicated at first glance, but all that these ratios are doing is expressing what the price of buying a company’s shares is - so you can compare different shares like you would similar products in any store……

The easiest way to think of it is that when buying shares, we are just buying their earnings. Investors use all these valuation ratios to try to see what they have to pay for a particular company’s earnings stream.

Simplistically, the lower these ratios are, the less you are paying for the underlying earnings the company makes in the future. You might not be paying much because earnings are falling or not expected to rise much and vice versa.

What makes it slightly more complicated is that not all earnings are created equal. Some companies are in a situation where because of factors such as their market position, their popular brand, their competitive pricing, or their innovative technology, investors can be confident that they can grow their earnings year after year.

If we believe that to be true, it would make sense for us to pay more as we are actually buying more as the company is likely to grow larger every year.

All roads lead to back to understanding what you are buying

“It’s better to pay a fair price for a great business than to pay a great price for a fair business” Warren Buffet

All roads in many successful investment strategies lead back to understanding the business you are buying before deciding what would be a fair price for it. So it’s important to ask yourself: is this share cheap for good reason or are things finally looking up for the business?

An expensive mistake would be to ignore what is actually happening within the business and just buy ‘cheap’ shares.

Many of the ‘cheapest’ shares in the market are facing a worsening future and you could still lose money however much they have already fallen because, as business conditions continue to deteriorate, prices could fall further.

Sometimes things are expected to change for the better at the company or sector level. This is when cheap shares can be good value investments. For value investing to pay off there usually needs to be some kind of catalyst to realise this higher value.

Don’t forget the magic of compounding returns

There is a logical reason why investors are prepared to pay more for a business which clearly has many years of pretty certain growth ahead of it. It’s value upside isn’t just about not being so cheap anymore relative to others, but about the possibility that it can keep on appreciating in value over the years as earnings rise. Sometimes this compounding returns investors many times their money.

The downside of paying more for a business in the hope that it has years of compounding growth potential is that the room for disappointment in these situations is high: the market is expecting a lot from them and if future profits disappoint, then investors could get badly burned.

Anyone can do it, Just Look Around You!

How can you tell which share is good value? Actually, it’s a lot easier than it seems.

Information really helps and for many businesses, it’s quite obvious even to the ordinary person when they are prospering relative to their competitors.

This is especially true if you use the products and services yourself. For example, anyone could have seen why people were buying from Amazon rather than their local bookstore. Conversely, it was quite obvious how few people were shopping in Marks and Spencer compared to the big queues after lockdown outside Poundland. By really looking around you, especially in your area of expertise or among the products and services you buy yourself, you have a great opportunity to find potential investment ideas which you really understand. It’s a huge advantage if you understand exactly why the winners are winning against their competition and the losers are losing and why this might continue. This kind of understanding lowers the risks of losing money on your investments.

Having found companies with great prospects, it’s important to remember that things can and do change over time. So something that was once very popular, you can see for yourself when more people are preferring other choices, or that competition has begun to really heat up.

For example, Starbucks enjoyed spectacular growth in many countries but gradually it was obvious that fewer people were choosing Starbucks as newer café chains opened up close by.

By understanding the business, you are in a better position to make judgements on what could go wrong and even see when that starts happening. Having more winners than losers amongst your investments in shares is the cornerstone to making good returns.

I’m fairly new into Pynk and the community and this is my first post on investing principles, so welcome any feedback you might have, what you would like to see more/less of in this community, and experiences on this topic.

Many thanks,

Pouneh

Disclaimer: this information does not constitute any form of advice or recommendation by Crowdsense Ltd. and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Appropriate independent advice should be obtained before making any such decision.

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Thank you sooooo much for these valuable infos Pouneh!!

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Thanks @pb1 for the very detailed explanation on what to look at within a company for investing purposes. Your expertise and background are definite assets to Pynk.

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Thanks for the share @pb1 Pouneh… I completely agree that when investing not everything is about the numbers, it is vital to understand a company and the environment where it operates, what’s driving the business, what opportunities lie ahead, and what problems might arise… I identify a similar preoccupation with what @PynkMiguel argued in his June piece: one must be careful when selecting investments and not just blindly follow the popular trend of the moment. I mean, one can be lucky when investing a couple of times, but if you’re only focusing on the price or a certain performance ratio, there is no way to get the whole picture of a company to really ponder if it is worth investing (or not); and eventually, an investor not following due diligence will run out of luck.

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Totally Agree Carlos. Good returns are about getting more right than you get wrong. Understanding the underlying business dynamics in terms of potential risks and rewards clearly helps to improve one’s hit rate …

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Lots of valuable information in this topic, Pynksters should read this! :smiley:

Most recent example I have for profiting on this in fantasy fund manager is actually from my friend using the product haha

He gets excited over every new top tier graphic card but recently he got more excited than usual and that was the final signal for me that it is ok buy the stock.
It was about new graphic card from Nvidia that he said is extremely good and price is not that high in comparison with other cards.
I was just thinking about whether or not to wait for stocks of graphic card companies to go lower before buying or buy now, and which one to choose (amd or nvidia).

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Thanks for this amazing post @pb1.

We are living through unprecedented times and there are many ‘bargains’ to be had in the stock market post COVID but, as you suggested, not every ‘bargain’ is exactly what it seems.

Let’s consider airline stocks (I won’t mention specifics) some are down by around 70- 80% and we all know exactly why but the question is: with a second wave of coronavirus looming, will they ever truly recover? Many companies could face bankruptcy.

I think an additional thing one could consider here is the ‘moat’ (as Warren Buffet would call it)
In other words, what is it that makes it unlikely that another company could replace it. To continue with your example of Amazon, the likelihood that someone could just show up tomorrow and replace Amazon is very very low. they have a global distribution, a strong brand and pretty much everyone checks them as the first point of call when doing most any kind of home shopping. So when the price does go down, one can be fairly sure at some point it will correct.

Thanks again @pb1 a really interesting topic!

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This is really educative. With Pynk, there is never a dull moment :muscle:t5:

Thanks @pb1

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Totally agree with you Al. On the subject of the obvious attractions of businesses enjoying Economic Moat Characteristics - ie structural factors which help the business protect their market position and by extension their earnings - I’m intending to write something sometime soon about this very subject!

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Great info!!! Thanks for share it.

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Thanks @pb1 this is very informative, I’m learning a lot by just reading your post.:grin:

Compound interest is one of the most useful concepts in finance. It is the basis of everything from a personal savings plan to the long term growth of the stock market. It also accounts for the effects of inflation, and the importance of paying down your debt.

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Hi fellows. Thanks for sharing this information. I’m at “zero” and trying to catch up with you in all this complex environment (at least for me😀). Although I understand that the numbers aren’t the only base for an investment decision, and all those reports make me dizzy, my question is: where to find valuable and reliable information about a company that could help answering those questions you have talked about. I’ll keep coming back to learn more. Thanks again. Cheers

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Hi @taliesin, generally if you have a company’s ticker (the abbreviated code for the company) you can just Google. For example, if you wanted to check Amazon, you could type $AMZN into Google and you’d get some information.

Yahoo finance is pretty good too. From yahoo finance you will get all kinds of metrics, including what other people think about whether the stock is a buy/sell/hold right now.

Hope that helps

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Morningstar is another informative place to get info @taliesin. I agree with @Al_Wallace about Yahoo finance too.

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Thanks @Al_Wallace and @KarenM for the info. :+1:

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Hi taliesin there are now many online resources (mostly free) where you can get a more in-depth and clear understanding of the underlying business and once you have a proper understanding, you are in a much better position to decide on what the company should be worth.

But even easier and perhaps more intuitive: as I explainEd in my article, you can find a wealth of investment opportunities where you are ideally placed to judge companies relative to their competitors if you look amongst the products and services you buy or in the industry where you work. This is a great starting point as you have the best perspective and clearest understanding why one particular company is doing better than others and importantly, you will be able to see in real time when they no longer have the most competitive offering. A lot of it is easier than you think and just common sense. I’ll be posting more articles on exactly this subject in the weeks ahead offering step by step practical advice.

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Agree with @Al_Wallace and @KarenM, definitely check out Yahoo! finance… it’s veeery user friendly (the app in particular is great) and there are tons of data on the companies you might be interested, you can even download most into Excel

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Thanks @pb1 for sharing. I’m looking forward and grateful for your articles. I believe I’ll learn a lot in this community. Cheers :hugs:

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Thank you so much for this worthy information

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This. Definitely this.

Should be a compulsory curriculum item in education; repeated at all levels, widening in scope as suited to the age group. Instil the lesson when young and repeat that lesson so it isn’t forgotten and is better appreciated.

It wasn’t without good reason that Einstein (probably never) said:

“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”

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