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SIA Fundamental Analysis

Value investing looks for undervalued stocks based on fundamentals like price-to-book and earnings multiples. There are three types of value investors: passive screeners who use ratios to identify mispricings like Graham, Dodd, and Buffett; contrarian investors who buy losers going against the market; and activist investors who take large positions in companies to enact changes. While value investing based on ratios has historically outperformed, various risks must be accounted for, such as higher risk, one-off earnings, or poor future growth. It is difficult for most investors to replicate Buffett's success due to less market inefficiencies, lack of capital/influence, and inability to withstand losses over time. A combination of top-

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53 views3 pages

SIA Fundamental Analysis

Value investing looks for undervalued stocks based on fundamentals like price-to-book and earnings multiples. There are three types of value investors: passive screeners who use ratios to identify mispricings like Graham, Dodd, and Buffett; contrarian investors who buy losers going against the market; and activist investors who take large positions in companies to enact changes. While value investing based on ratios has historically outperformed, various risks must be accounted for, such as higher risk, one-off earnings, or poor future growth. It is difficult for most investors to replicate Buffett's success due to less market inefficiencies, lack of capital/influence, and inability to withstand losses over time. A combination of top-

Uploaded by

benbenben3
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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SIA – Fundamental Analysis

Value Investing
School of thought pioneered by Ben Graham and David Dodd. Essentially looking for stocks that are
undervalued.

Value investors only concerned with current value in the belief that if there is a mispricing in the
market then this will be corrected.

Three different types of Value investors:

Passive Screeners:
Graham, Dodds and Buffet fall into this category. Looking at the key ratios in order to identify mis-
pricings.

Ratios:

1. Price / Book ratios


a. Fama and French (1972) low P/B ratio 24.31%. high P/B 3.7%. 1963-1990
b. BUT may be due to higher risk being taken on
i. Can compose composite measures also taking into account risk
c. BUT low price to book value may be rationalised by low expected returns
2. Earnings Multiples
a. Damodaran (2003) low price to earnings:
i. 10% excess 1952-1971
ii. 9% excess 1971-1990
iii. 12% excess 1991-2001
b. BUT earnings may be high from one off e.g. pensions
c. BUT might be low due to low or even negative growth
d. BUT low P/E might have large dividend yield which is taxed
3. Revenue Multiplies
a. Levy and Jacobs (1988): low price/ sales, 2% excess return 1978 – 1986
b. BUT could have low margins
c. BUT could have high leaverage (i.e. high fixed costs so not much profit)
4. Dividend Yield
a. ‘Dow dogs’ buy top 10 firms in DOW based on Div.
b. Hirschey (2000) no excess returns when adjust for risk.

Contrarian Investors
Picking losers and going against the market. Two strategies: buying losers and playing the
expectations game:

Buying Losers
 DeBondt and Thaler. 1933-1978, pick 35 winners and 35 make 30% returns and beat the
market

BUT

 Jegadeesh and Titman. For 12m the losers are still losing compared to the winners
 When control for size no excess returns

Playing the Expectations Game


 Tom Peters identifies Excellent and Unexcellent firms finds 1981-1985 Unexcellent ones
perform better.

BUT

 Not controlling for risk above


 Could have poor management entrenched with anti take-over laws or voting share
 Firms often get worse before they get better

Activist Investors
Take over a firm and are vocal in trying to get it to change. Must:

 Be very well capitalised in order to gain control of a large enough part of the company
 Be well regarded to get other shareholders to side with you against management
 Be prepared to battle incumbent management
 Be able to commit a lot of time towards it.
 Warren Buffet has been categorised as this recently e.g. his vocal disapproval of the Cadbury
Kraft deal.

Why don’t people just Imitate Buffet?


1. The world is not the same as it used to be there are much less oportunites to spot
mispricings due to digitalisation and lots more info available at lower cost
2. Buffet became more of an activist behaviour, Average Joe couldn’t replicate this since don’t
have the capital or influence
3. Buffet has been patient in waiting for firms to become profitable through bad years,
stakeholders would not let anyone get away with this but Buffet has built up a reputation.
Top down vs Bottom Up
Industry vs Firm effects
Porter and McGahan (1997) – Stable industry effect= 19%. Stable firm effect= 4%. (of variation in
returns)

Rumlet (1991) 1974 – 1977 – Stable industry effects= 7.6%. Stable firm effect= 46%. “unique
positions, endowment and strategies”

In reality used together a lot of the time will look at industries and then look at particular firms
within industries.

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