'Value Investing' by Prof. Greenwald

Professor Bakshi has uploaded Professor Bruce Greenwald's notes on his website (here). Prof. Greenwald from the Columbia Business School, was in Mumbai to deliver a talk titled, "Value Investing Frameworks and Business Analytics" (post by Prof. Bakshi)

In an article published in The Motley Fool, Prof. Greenwald shared his learning in a 5-part series. I've enclosed some parts of these in the post.

Part 1 : VALUE INVESTING 101 (here)

1. Simple stock search strategy : go for ugly, traded-down, cheap, boring -- as opposed to glamorous, respectable, lottery-ticket type and prominent stocks.

2. Develop a valuation technology : The Graham technology is starting with the most reliable information, which is asset value, then looking at the second-most reliable information, which is current earnings -- with all the appropriate adjustments and getting an earnings-power value -- and then looking at those two and see what they tell you about the extent to which you are buying a franchise, which is value in excess of assets. And then, only then, looking at the growth.

3. Patience : You have to have confidence in your valuation. If nothing has changed about the underlying value of the company, then if it's a good stock at 8, then it's a better stock at 4.


Part 2 : TO HOLD CASH OR NOT? (here)

4. Valuations may be high but in general, don't just throw away the market : If you're an equity manager - what's your risk? It's deviation from the market. So if you have nothing to do, you might as well minimize risk and buy a full market portfolio, and that's that.

5. Determine your risk tolerance : Look at it this way, if you're being given institutional funds that the institution wants to allocate to equity, you got a different risk profile on the returns on those funds than if you're managing a family's entire wealth where they care about absolute returns.


Part 3 : THE ART OF SHORTING (here)

6. One of the most restrictive clauses of the value discipline is 'no short selling' : Value investors are nervous about short selling for two reasons.
a) Tax treatment of short gains
b) As the stock goes up and the short goes against you, your risk goes up as opposed to going down. (I think the professor means that as the price of the stock goes even down, your opportunity should increase such that you can accumulate more. But you are on a long position and when the stock goes down, the shorting turns the advantage into a loss).

7. In shorts, much more than longs, you obviously want to look for a catalyst : This can be a restructuring or an earnings disappointment etc.


Part Four : IDENTIFYING FRANCHISES (here)

8. The way to think of growth in the simplest possible terms is growth requires investment : Everybody on Wall Street sort of talks about scalability and growth without investment, but if you look at the history of any growing firm, the amount of capital they put in grows with the growth in the firm. It just tends not to be scalable.

9. A franchise : is something that you can do that your competitors can't. And there are really only three possibilities.
a) It is increasingly rare in a rapidly changing world is that I've got technology that they can't match. That I can do it at a lower cost than they can. Those things go away very quickly, because people can copy technology. It's usually only in very complicated process industries that you have -- and some pharmaceuticals where you're patent protected, that you have technological advantages.
b) Customer captivity is probably going down a little. The Internet makes it very easy to compare prices. It's the enemy of profitability in that sense. But if you look at repeat purchase behavior, it probably hasn't changed all that much.
c) Can't match my cost, even though they've got the same cost structure, because I have economies of scale and they don't.


Part 5 : THE ONE INVESTOR TO BET ON (here)

10. If I were going to start off as an investor, I would start with Ben Graham's book, The Intelligent Investor. It's not because he lays out all the really good ideas that he had perfectly, but it's just a terrific introduction to the attitude it takes to be a successful investor.