ranchi_lecture on value investing

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INTRODUCTION TO VALUE INVESTINGIIM Ranchi

March 16, 2015



“We think the very term “value

investing” is redundant. What is“investing” if it is not the act of seeking

value at least sufficient to justify the

amount paid. Consciously paying more

for a stock than its calculated value —

in the hope that it can soon be sold for

a still-higher price — should be labeled

speculation (which is neither illegal,

immoral nor — in our view —

financially fattening).” — Warren Buffett



“An investment operation isone which upon thorough

analysis promises safety of

principal and a satisfactory

return. Operations not meeting

these requirements are

speculative.” — Ben Graham



Three Key Principles of

Investing



Principle # 1: “Investor should

look at stocks as part

ownership of a business.”



Principle # 2: “Investors should

look at market fluctuations in

terms of Graham’s “Mr.

Market” example and “make

them your friend rather than your enemy by essentially

profiting from folly rather than

participating in it.”



Principle # 3: “The three mostimportant words in investing

are “margin of safety”, which

means “always building a

15,000 pound bridge if you’re

going to be driving 10,000

pound trucks across it.”



“When you build a bridge, you insist it can carry 15,000

pounds, but you only drive 10,000-pound trucks acrossit. And that same principle works in investing.” —

Warren Buffett



The Idea of “Margin of Safety” is based on the idea of

Redundancy in Engineering

http://en.wikipedia.org/wiki/Redundancy_(engineering)



Sources of Margin of Safety



Margin of Safety From A Low Price



In American roulette there are 38 slotsnumbered 1-36, 0, and 00. Pay-out is 35:1



If you bet Re 1 on your lucky # 8 and if theball lands on # 8, you win Rs 35, otherwise you

lose Re 1.



You wager Rs 1,000 on a single number, say number 7.Probability of ball landing on 7 = 1/38 = 2.63%.Probability of not landing on 7 = 37/38 = 97.37%



Event Payoff Probability Expected Value

Ball lands on 7 36,000 2.63% 947.37

Ball does not land on 7 0 97.37% 0

947.37

Amount Bet -1,000

NPV -52.63

Suppose you bet Rs 1000/38 or Rs 26.32 on each of the 38

numbers to “spread your risk”



Event Payoff Probability Expected Value

Ball will land on one ofyour numbers

947.37 100% 947.37

Amount Bet -1,000

NPV -52.63

Lesson: Diversification does not work when Margin of Safety isabsent.



Each bet has an expectancy of a profit even though

some will inevitably result in a loss

Wide diversification

Cap on Max Bet



Four Businesses



Some Principles

Principle # 1: Assets are worth more than book value

when they are expected to earn a return on capitalemployed which is more than market rates of return.

And Vice Versa.



Some Principles

Principle # 2: Assets lodged in the hands of a manager

who thinks and acts in the interests of the owners areworth more than identical assets lodged in the hands of

a self-interested manager.



Some Principles

Principle # 3: All growth is not good. There is good

growth and there is bad growth. Good growth creates

value. Bad growth destroys it.



Some Principles

Principle # 4: Quality matters.

“Leaving the question of price aside, the best business

to own is one that over an extended period can employ

large amounts of incremental capital at very high rates

of return. The worst business to own is one that must,

or will, do the opposite - that is, consistently employ

ever-greater amounts of capital at very low rates ofreturn.” — Warren Buffett



Some Principles


“The worst business of all is the one that grows a lot,where you’re forced to grow just to stay in the game at

all and where you’re re-investing the capital at a very

low rate of return.” — Warren Buffett



Some Principles


"Time is the friend of the wonderful business, the

enemy of the mediocre.”



"If a business earns 18% on

capital over twenty or thirty

years, even if you pay an

expensive looking price, you'll

end up with one hell of a

result." — Charlie Munger

Some Principles




Some Principles

Principle # 5: Price Changes Everything

“Leaving the question of price aside, the best business

to own is one that over an extended period can employ

large amounts of incremental capital at very high rates

of return. The worst business to own is one that must,

or will, do the opposite - that is, consistently employ

ever-greater amounts of capital at very low rates ofreturn.” — Warren Buffett



(Compound Interest + Longevity) + Reasonable price =Wealth Creation

Key Questions:

What produces (Compound Interest + Longevity)?

What produces Reasonable Price?



Various Sources of Moat

Intangible Assets

Customer Switching Costs

Network Effects

Low Cost AdvantageNiche

Corporate Culture

Reputation



It is useful to think about moats from the perspective

of customers as well as competitors



(Compound Interest + Longevity) + Reasonable price= Wealth Creation

Key Questions:

What produces (Compound Interest + Longevity)?

What produces Reasonable Price?



“The capital asset pricing

model type reasoning with its

different rates of risk adjusted

returns and the like, weconsider, it nonsense.”



But we think it’s also nonsense to

get into situations – or to try and

evaluate situations – where we

don’t have any conviction to speak

of as to what the future is going to

look-like. I don’t think that you cancompensate for that by having a

higher discount rate and saying,

“Well, it’s riskier. And I don’t really

know what’s going to happen.Therefore, I’ll apply a higher

discount rate."



SUMMARY

All investing is value investing but there are three key principlesto follow. (1) Business Underneath Every Stock; (2) Mr. Marketcan be Wrong; and Margin of Safety is Important.

A Fundamental Principle: (Compound Interest + Longevity) +Reasonable price = Wealth Creation

Investors Should Spend Time Understanding the Above Equation.



– Sanjay Bakshi

Thank You

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