Notes on Value Investing

This is a bundle of somewhat unstructured notes from a Twitter Spaces event about value investing. The Spaces event was put on by a good friend of mine, Jason Wong, almost a year ago (May 21st, 2022). While going through my notes recently, I realized that these bullets might be worth publishing if I could turn them into a slightly more readable document. This is about the best I could do. I hope it provides value :)

Core concepts

• If you apply yourself, your own deep research and the resulting expertise you gain will result in a stronger portfolio than if a generic Wall Street management firm builds a portfolio for you.
• The core skill of a value investor is the ability to distinguish price from value. Your job as a value investor is to find valuable companies that are priced below what they should be.
• Before investing, sleep on your research and reflect on your prospective investment. Take this time to evaluate the true value of the asset you are planning to purchase. You will instinctively feel if something is “off” or “weird”.
• Learning how to bridge your knowledge of a specific industry with your analysis of stocks in that industry is a superpower. There are two ways to do this:
  1. Start investing in an industry you already know very well, and selectively invest in stocks that you know will perform well in that industry because of an information asymmetry you can leverage.
  2. Learn about an industry by going directly to the source, and getting data from the companies in that industry. To do this, you should:
     • Get to know the company and its leadership more intimately.
     • Try to cut out the noise of external analysts and listen to the company’s conference calls.
     • Research the company’s operations and clients in depth to understand if the company occupies a critical position in society and has valuable customers.
     • Research the industry to see if the company makes sense in the broader context of what you learn about the industry.

Heuristics in practice

• When you are analyzing the value of a stock, follow these steps:
  1. Analyze if the products, commodities, or services that the company produces are valuable to society. If they are not valuable, look for another company. If they are valuable, continue on to step two.
  2. Figure out just how valuable these products, commodities, or services are. Are they absolutely critical, or relatively superfluous? Companies that are critical to the functioning of society are usually better value investments.
  3. Analyze the company’s cashflows and other key indicators: P&L, Balance Sheet, and Cash Flow Statement. Looking at these key indicators is like looking at the “blood pressure, cholesterol, and heart rate” of a company.
• To dig deeper, read company filings.
  • You can easily access these filings by searching for quarterly and annual corporate filings on sec.gov and checking investor relations pages on the websites of publicly traded companies.
  • Some billion dollar companies have only 20 people reading their investor filings, which is crazy! If you are willing to do your own research you can outperform Wall Street. 
• You must ask: How much cash does the company have?
  • How strong is the Balance Sheet of the company? Cash is the lifeblood of a business, and no company can survive without it.
  • The “no one reads the bonds” moment from The Big Short is quite accurate. People rarely read company filings and understand the true financial standings of the companies they invest in. If you simply avoid investing in companies with weak Balance Sheets, you will save yourself a lot of pain.
  • Note that it’s easier to estimate cashflows for some companies that are commodity based (e.g. fertilizer companies) because you can see fluctuations in the commodity price in advance of a shift in the market, and you can price that into the value of the stock. That’s a great trick.
• When stock prices are down, it is your time to engage as a value investor! Doing so is the equivalent of shopping on Black Friday.

Effectively discovering value

• Your job as a value investor is to discover true value. This process of discovering true value is somewhat akin to being a miner — it takes a lot of effort to unearth a valuable company, but that effort is a barrier to others doing the same. Use this to your advantage.
• What indicators, aside from cashflow, are good to look at?
  • Irrespective of price, is the company actually valuable to society in the medium- and long-term? Are the products the company produces actually used and necessary?
  • Companies that are valuable to society will win in the long-term. Energy companies are a great class of stock, because they are critical and valuable to society, and energy is required for almost every other operation in society. Well-managed, critical companies are hard to kill.
  • Do you love what the company does? 
  • If you don’t love the mission of the company, don’t buy the stock. Buy what you love and hold it for the long term — investing wisely is not just a way to make money, but also a way to positively change society.
• How should one invest with smaller amounts of money, or with no money?
  • Even if you have no money, you should learn to set yourself up for future investing. You can practice investing using virtual trading accounts to see how your hypothetical investments perform over time, and gain experience in this way.
  • If you do have money to invest, having less money when you start can be a positive. You want to make your mistakes early, when you have less money. Get your mistakes out of the way when you have less money to invest, so that when you have larger amounts to invest you will not make those same mistakes.
  • Once you are ready to invest, pick one or two stocks, or a small handful (no more than five). Follow these stocks closely and seek to deeply understand their operations and cashflow. As you continue to better understand the company, if you see issues that can be addressed, try to raise them with the company leadership or board. See if they are receptive to your feedback — this is a good sign for a long-term investment.
• How should you decide when you should cut your losses?
  • Think about the stock price as an indicator of investor psychology ABOUT the value of the stock, rather than a true indicator of the value. Mania = higher prices, depression = lower value. The truth lies somewhere in the middle, and it is your job to find where that is. Emotions are not truth.
  • By extension, DO NOT let investor sentiment override your knowledge about the value of a company. In bear markets, babies get thrown out with the bath water. Save those babies!!!
  • If you have truly made a mistake in your investment and the key indicators of the company back that up, then cut your losses immediately. Do not fall prey to the sunk-cost fallacy!

What investing gets you beyond making money

• Investing helps you see that smart people can have different perspectives about the same events and facts. This demonstrates that perspectives and opinions are not truths.
• Learning how to invest, and taking the time to invest judiciously, is an incredibly valuable mental exercise.
• The habit of saving money and analyzing the world through an investment-oriented mindset provides perspectives and insights that you will not find elsewhere.
• You can be a value investor in more than just companies. In fact, there many kinds of value investments. Building friendships, cultivating relationships, spending time to learn, and founding a company are all forms of value investing. If you get in the habit of thinking about the world through a long-term value-oriented mindset, it will pay dividends.