|
| |
|
|
Is This The Right Time To Buy The Stock? |
|
|
You have zeroed in on companies that have great businesses. You are also satisfied that the quality of management is strong. Does this mean that you can go ahead and invest in the stocks of these companies? Not yet. The decision to finally go ahead and take the plunge will be based on valuations. Indeed, this is the most important of all the steps because valuations decide the action points (buy or sell) of investors. Now, investing is knowing exactly what you are paying for today rather than speculating and over paying for you could possibly get in future. And in order to know the correct price to be paid, you need to assess the value of the underlying asset correctly. Only when the investor understands the moat the business enjoys and the risks to it, can he determine the intrinsic value and price he would be willing to pay, with adequate margin of safety. But determining value is a tough task. That's because it involves forecasting future cash flows which in itself is a challenge. Discounting those cash flows at an appropriate rate gives us an estimate of value. However, forecasting cash flows for a business is not easy because of the uncertainty involved with the future, unlike coupon bonds. Valuing coupon bonds is relatively easier since you know the coupon payments of future. But that is not the case with businesses. So, basically the mantra is to look out for businesses that resemble coupon bonds. This would make the valuation exercise easier. In other words, businesses where forecasting future cash flows is relatively easier are the ones that should be on the radar. Now, forecasting future cash flows involves an estimate of growth rate. The idea here is to be conservative. If the growth rates are higher, then the estimate of intrinsic value will increase. And investment decisions are based on comparing intrinsic value with the market price. Thus, your estimate of intrinsic value has to be as accurate as possible. High growth rates make intrinsic value more susceptible to changes. Hence being conservative pays off. That all important margin of safety The concept of margin of safety is the essence of Buffett's valuation. Since the estimates of intrinsic value involve subjective judgments there is a possibility of being overly optimistic. Margin of safety provides cushion by adjusting the optimism from the forecast. Say for example your estimate of intrinsic value is Rs 100. Taking into consideration a margin of safety of 20% you adjust the value to Rs 80. This will ensure that you do not overpay for any asset. Let us take the example of Swaraj Engines. When we recommended the stock for our second ValuePro portfolio in January 2013, it was trading at a discount of around 40% to its intrinsic value. We felt at the time that the valuations were very attractive and recommended that investors buy the stock for the second portfolio. This stock went on to do very well garnering returns of more than 80% till the time we closed the position in August 2014.
This once again highlights that the trick is to buy stocks at the right valuations with a sufficient margin of safety if you want to generate long term wealth. So to sum up, if you want to pick stocks the Warren Buffett way and create a solid long term and extremely profitable portfolio, then you need to focus on companies with an unbreachable moat, a strong management and trading at a sufficient discount to its intrinsic value. Now what if I were to tell you that we have already created two such portfolios based on these very principles of value investing that I have discussed. And you have a chance to have access to both these readymade portfolios. Indeed, this is a chance for you to invest like Warren Buffet himself and achieve your goal of building wealth in the long term. To know more about this, please click here. |
