Source: Qilehui.

1. Investors' attitudes towards risk.

Famous investor Seth Klarman believes that the future is unpredictable. Investors who try to avoid losses must survive in various situations until prosperity is achieved.

Misfortune may also fall on investors. As the situation where the river water overflows the bank may only appear once or twice in a century, but each year you still buy insurance for your home, and the economic depression or financial panic may only appear once or twice in a century. Visionary investors are willing to give up short-term returns as insurance premiums paid for unexpected disasters.

Sometimes investors set specific return rate targets for their investments incorrectly. Klarman pointed out this error and said: Investors cannot achieve higher returns by working harder or longer.

All investors can do is follow a disciplined and strict method, and ultimately obtain returns over time. Setting specific return rate targets for investors will only make them focus more on the potential for growth, ignoring risks.

Klarman pointed out that on the contrary, investors should focus on setting risk targets, not return rates. Most investment methods do not focus on avoiding losses, and only value investing does.

2. The importance of margin of safety.

Klarman pointed out that value investment conducts conservative analysis of potential value, and combines this indispensable discipline and patience only to buy when the price is cheap enough. The value investor needs to strictly follow the discipline when looking for bargains, which makes the value investing method look very much like a risk avoidance method.

The biggest challenge for value investors is to maintain the required discipline. Becoming a value investor often means standing with different crowds, challenging traditional wisdom, and opposing popular investment trends. It may be a very lonely task.

For a value investor, the ball must not only be in his hitting area, but also must be in his "most ideal" hitting area.

When investors are not forced to invest too early, the results they achieve are the most ideal. Sometimes dozens of good balls will come to investors in a row. For example, in panic markets, undervalued securities will increase a lot, and the degree of undervaluation will become larger and larger, and investors must carefully find the most attractive investment opportunities among these bargains.

However, in bull markets, undervalued securities will become rare. Value investors must strictly follow the discipline to ensure the integrity of the value evaluation process and limit the price paid.

In fact, the so-called "margin of safety" evaluates the intrinsic value of the company with a conservative attitude, and compares it with the market price to determine the size of this difference. The importance of margin of safety has been highly valued by Graham and Buffett and regarded as the foundation of value investing.

Klarman reminded investors that it is difficult to determine the intrinsic value of a company and it will not remain unchanged.

Macroeconomic and industry competition factors will change the potential value of the company. When there is a possibility that the intrinsic value of the company will continue to decline, it is like a dagger inserted in the heart of value investment. Value investors give great trust in evaluating value and buying at a certain discount rule, but if the intrinsic value of the company suffers a significant depreciation, how much discount is enough?

Value investors should be concerned about the potential decline in company value, and there are three effective responses:

First, investors always give conservative evaluations and pay attention to the liquidation value under the worst-case scenario and other methods. Second, investors who are concerned about deflation can request more margin of safety discounts. Finally, the prospect of asset depreciation has raised the importance of investment time and catalysts that can realize potential value.

Klarman believes that investment is a science and an art. Investors need a margin of safety, which allows people to make mistakes and enables investors to obtain a margin of safety when encountering misfortunes or extremely volatile worlds that are complex and difficult to predict.

Charlie Munger once said: Investment is a discipline of taking prices for values, and the trick is to exchange the lowest price for the highest value.

Klarman also pointed out that what kind of margin of safety should investors have varies from person to person depending on their ability to bear losses. There is still controversy about how much margin of safety is appropriate, but there are some elements that can help us better judge.

For example, the emphasis on tangible assets in a company should exceed the emphasis on intangible assets. Evaluating intangible assets requires some art.

In fact, many outstanding investors, including Buffett, have realized the huge value of intangible assets. They can continue to grow on the basis of minimal capital reinvestment, and ultimately all cash flow generated by these intangible assets is free cash flow. But there is no doubt that evaluating intangible assets is more difficult.

Investors should not only focus on whether the investments they hold are undervalued in the current period, but also on why they are undervalued.

Understanding the margin of safety seems to be confirming the intrinsic value of the investment company. But in fact, there is a great misunderstanding. The margin of safety does not seem to be the same as the evaluation of the intrinsic value of the company.

I have always had doubts about this because whether it is an evaluation based on the balance sheet or an evaluation based on the future cash flow discount, it looks like a rigorous science. But I understand that the evaluation of the intrinsic value of the investment company based on the concept of margin of safety is not the same: value investors evaluate the margin of safety based on conservative expectations.

Rigorous value investors always picky judge the rationality of the company's asset value and their expectations are always biased towards conservatism. In the long history of investment, the initial investors are all looking for a safety margin based on tangible assets, such as Graham's net operating capital (net working capital) discount to provide a safety margin.

But as the market gradually matures, value investment is widely recognized, and such a margin of safety is becoming more and more rare. Except for a few extreme periods, the US stock market rarely provides such opportunities on a large scale.

With the rise of the tertiary industry and the modernization of industry, there are more and more companies that operate with light assets, forcing investors to shift their focus to the evaluation of intangible assets.

On the one hand, this increases the difficulty of value investment, and on the other hand, it is easy to generate larger market bubbles (because the difficulty of evaluating intangible assets makes investors more dependent on future expectations, and expectations often lead to unrealistic blindness).

3. Value investment shines in falling markets.

Kalaman believes that the securities held by value investors do not need to be supported by very high expectations. On the contrary, they usually do not cheer or simply ignore such high expectations.

One prominent feature of value investment is that it can achieve excellent performance during the entire market downturn. In any case, as long as the market does not completely reflect the intrinsic value of the fundamentals in prices, investors can achieve high margin of safety.

The pricing of some securities in a declining market is like these companies are struggling, and cognitive changes will benefit the prices of such securities. If investors refocus on the advantages these companies possess rather than their difficulties, prices will rise. When the fundamentals improve, investors can benefit not only from performance improvement but also from the increase in valuation of these securities.

Kalaman's point is simple: Only when the market drops significantly can it provide more opportunities for value investors, because in panic declining markets, people's attention is often focused on current difficulties and short-term difficulties are often extrapolated to the future (the short-term may be several years or even 10 years).

Once the trend reverses, value investors can benefit from both performance recovery and valuation recovery. In normal market cycles, value investors try to find investment targets with a margin of safety, which is very difficult. At these times, investors are relatively easier.

Therefore, from another perspective, value investors in normal markets need great experience and self-discipline to find "relatively undervalued" varieties with a margin of safety.

4. Three elements of value investment philosophy.

Kalaman pointed out that there are three factors in the value investment philosophy. Firstly, value investment is a bottom-up strategy. Secondly, value investment pursues absolute performance, not relative performance. Finally, value investment is a risk-avoidance method.

From the bottom-up investment strategy, many professional investors choose stocks from top to bottom, that is, predicting the macroeconomic trend, industry and company prospect, and analyzing what reaction other investors will have to decide whether to invest and what kinds of stocks to invest in. Investors who adopt top-down investment strategies must make accurate judgments about information and forecasts, and they must be fast.

Value investors always pursue absolute returns rather than short-term relative returns.

Most fund managers obviously pursue relative returns, especially short-term performance, and therefore are sometimes forced to follow the market trends to buy and sell stocks. Value investors don't need to worry about these issues. They can boldly pursue those varieties that have attractive long-term returns but may perform poorly in the short term.

The viewpoint of high risk and high return is wrong. Karaman believes that the market is often inefficient, and high risk does not always bring high returns. Similarly, low risk sometimes brings high returns. Many investors' understanding of risk is incorrect. A bond has risk when it defaults, but the fact that it pays at maturity does not mean that there is no risk.

Investors determine that low risk may be a risk that they know after the investment ends and will not be more than the investment decision. Karaman believes that investors can only do several things to deal with risks: diversify investments adequately; hedge if appropriate; and invest with a safety margin. When there is an error, cheap prices can provide a buffer.

Investors must realize that the cornerstone of value investing - a safety margin - is also a relatively vague concept. To be precise, real safety margins only appear in a very small number of periods. This is also one of the reasons why Graham gave up his faith in value investing in his later years: in that era, the United States was difficult to find very cheap stocks.

In a situation where many blue-chip stocks in a country's stock market have a market value lower than net assets, or even net operating capital, value investing can truly play its theoretical role. But most of the time, value investors must face embarrassing situations: they are forced to raise the standard of "safety margin" requirements, or turn to trend investors.

This may also be the biggest tragedy of value investing theory.

5. Enterprise valuation art

Karaman directly defines enterprise value appraisal as "art", which shows that he believes that enterprise value appraisal is not a rigorous science, but depends more on investors' personal experience, knowledge and even intuition.

Karaman even pointed out that enterprise value is not only difficult to accurately measure, but it will change with the passage of time and macro and microeconomic fluctuations. Investors cannot clearly judge the value of the enterprise at a certain moment and must constantly reevaluate their predictions of the value of the enterprise.

Any attempt to accurately evaluate the value of an enterprise will bring inaccurate evaluation results, in a nutshell, "garbage in, garbage out". Graham has already made it clear that the purpose of securities analysis is only to determine if the value is enough to support the purchase of a bond or stock, and rough and approximate measurement of the intrinsic value may be enough to achieve this purpose.

Karaman proposed three methods of value investing to evaluate enterprise value:

The first is the analysis of the continuous operating value, that is, the net present value NPV method, that is, the calculation of the discounted value of all future cash flows that the enterprise may generate. There is also the previous acquisition transaction price of comparable companies as a measure.

The second is the liquidation value method, that is, considering the highest estimate of each asset of the enterprise, regardless of whether it is bankrupt.

The third is the stock market value method, that is, predicting the trading price of a company's split on the stock market and using it as an evaluation value standard.

For the first important evaluation method, predicting the future cash flow or profit growth of the enterprise is a dangerous job. Investors should avoid falling into blind self-confidence or giving too high expectations to growth stocks. But some sources are more predictable, such as revenue growth brought by population growth, and the stability of earnings growth of companies whose consumption habits are not easy to change will be slightly higher.

Generally speaking, it is much simpler to find the sources that may increase corporate revenue and predict how much the final corporate revenue will increase and how these sources will affect profits.

How do investors analyze unpredictable things through predictions? The only answer is to maintain a conservative position. Then you can only buy securities at prices that are much lower than the value evaluation based on conservative predictions.

The choice of discount rate is also subjective. Many times, investors will give too low discount rates in low interest rate cycles, but in fact interest rate cycles are always fluctuating, and investors should not take a specific period of market interest rates as the discount rate.

Generally speaking, even the discount rate should be conservative. A higher discount rate, such as a 10%-12% discount rate, will be safer. Buffett is said to like to use a discount rate of 10%, and some said he likes to use the long-term US Treasury bond yield as the discount rate.

6. The reflection relationship between market price and potential value

Karman particularly pointed out that a complex factor in securities analysis is the reflexive relationship between security prices and potential enterprise value. That is the reflexivity principle that Soros believes: stock prices sometimes have a huge impact on enterprise value. Karman believes that investors must remember this possibility.

For example, when banks have insufficient capitalization ratios (capital adequacy ratios), if their stock prices are high, then the bank can issue new shares and achieve self-sufficient capitalization (increase capital adequacy ratios), which is a form of self-fulfilling prophecy. At this time, as long as the stock market says there is no problem, there is no problem.

However, if the stock price of the bank that urgently needs to supplement capital is at a low level, or even unable to make up for the capital, it may directly lead to the bank's bankruptcy, and the negative self-fulfilling prophecy is realized. Sometimes, leveraged financing and enterprises with debts approaching maturity are also the same. The market price may directly lead to changes in the fundamentals, thereby providing more sufficient reasons for the market price.

It can be said that the problem of reflexivity in banks is one of the most fully reflected cases of reflexivity principle.

Seth Karman's book is truly one of the most valuable classic value investment works to collect. Personally, I think it is enough to be an entry-level value investment model on par with "The Intelligent Investor", but in terms of rigor, it is still not comparable to "Security Analysis".

His article in October 2007 at the Massachusetts Institute of Technology speech is a classic that can be printed and placed on the bedside. The title of the article is also classic: "Sleeping well at night is more important than anything else!" The last sentence is also a warning:

Investors should always remember that the most important benchmark is not the return obtained, but the return obtained relative to the risk undertaken! For investors, sleeping soundly at night is more important than anything else!

7. Value Investment and Contrarian Thinking

Karman believes that value investing is essentially contrarian investing.

He pointed out that unpopular securities may be undervalued, and stocks that are deeply popular will almost never be undervalued. So if value investment is unlikely to appear in securities that are currently being purchased by the crowd, where might value appear?

Karman believes that value appears when it is sold off, unnoticed, or ignored.

However, investors may find it difficult to become contrarian investors because they can never be sure if they are correct and when they can prove themselves correct. Because they are fighting against the crowd, contrarian investors are almost always wrong at the beginning and may even suffer losses on paper for a period of time.

However, those who operate with the crowd are almost always correct in the initial period. Contrarian investors are not only wrong at the beginning, but they may even have a higher error rate than others, and the time for which their errors persist may be longer. Because market trends can keep prices away from value for a long time.

Contrarian thinking is not always helpful to investors. When widely accepted views do not affect the securities held, no benefits can be gained from going against the current. However, contrarian thinking can be useful when mainstream opinions do affect the outcome or probability.

For example, when people rushed to buy family medical care stocks in the early 1990s, the prices of such stocks were greatly pushed up, thereby reducing returns. At this time, most people have changed the risk/return ratio, but they are unaware of it.

And when most investors ignored and criticized Nabisco in 1983, when the company's stock price was lower than that of other excellent companies, the risk/return ratio became more favorable, thereby creating a buying opportunity for contrarian investors.

Karman's contrarian investment is not a light tone, and this is also resonant in John Neff's writings. This value investment master described the essence of value investment in this way: "Value investment is the pain you bear after buying." He said that the idea that value investment is just waiting for success after buying is how childish.

Going against the mainstream thinking sometimes puts investors in very awkward situations, but it is still deeply understood by Charlie Munger, who pointed out that

Contrarian thinking is always beneficial, but the key to your success is not that you think against the mainstream, or whether others agree with your views, but whether your reasoning is correct and whether the facts on which your reasoning is based are true.

8. How much research and analysis do value investors need?

Karman raised a very thought-provoking question. He pointed out that some investors insist on trying to obtain all information related to their upcoming investments, conduct in-depth research on the industry and corporate competition, communicate with employees, industry professionals, and analysts, understand the company's management, and study the company's past financial data. Such diligent research is commendable, but there are two shortcomings to this approach.

Firstly, no matter how hard investors try, some information will always be left out, so investors must learn to adapt to the incomplete information.

Secondly, even if investors can know all the information related to a particular investment, it does not necessarily mean that they will benefit from it.

At first glance, Karman's statement seems very confusing: if such diligent research and striving to obtain all information cannot guarantee investment success, what should value investors do? He analyzed and said:

"This is not to say that fundamental analysis is useless, but information usually follows the 80/20 principle: the initial 80% of information can be obtained within the initial 20% of the time spent. Business information is easy to change, and trying to collect all information will only decrease investors' returns."

Generally, high uncertainty often accompanies low stock prices. However, when uncertainty gradually disappears, the stock price may have already risen. Therefore, although value investors may have failed to grasp the unanswered questions, low stock prices can provide a margin of safety for them. Other investors may miss the opportunity to buy at low prices because they focus on researching these residual details.

Karman believes that value investment research is about reducing a large amount of information to manageable information. The research process itself will not generate profits. The only thing investors need to do is to find undervalued investment opportunities discovered during the research process, and the market will eventually realize the value.

His meaning is somewhat like "among thousands of streams, I only take a sip". This is also the case for many institutional analysts. Although they cherish the companies they research, most of them still cannot translate their research results into profits. It can be seen how difficult it is to invest.

Editor / jayden