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Sunday, March 26, 2017

Simple Fundamental Approach on Value Investing

Author: Mohamad Jeffrey Ismail | Publish date: Sun, 26 Mar 2017, 12:53 AM

Before deciding to buy any stock, an investor should at first examine the entire business by getting necessary information about the fundamental aspect of the business, doing complete analysis, and finally arriving at valuation.

Of course by doing good examining the business, it does minimize the risk (chances of permanent loss of capital) of our investment. The more you understand the business, the lower the risk you would take, thus the better the potential return you could make.

In order to do that, value investors need an investment process that he should follow during examining any company he would like to invest.

Step 1 : Determine the suitable business

As point of starting, value investor usually looking for the area that he familiar with, or we called circle of competence. For example, it is much more hard for an oil and gas engineer to understand a pharmaceutical business rather than he could understand the business of an oil company. So it is better to stay within our circle of competence rather than walk outside of it, think as if we can undertand the business well.
Step 2 : Getting neccessary information

The next step is to get necessary information for further analysis of the business. This information might be found mainly on company annual report and through out research. Lacking of necessary information make analysing process become difficult so as valuation process.
Step 3 : Analysing and interpreting data

This includes analysis of company financial data, economic moat analysis, prospect and company risk analysis as well. It is important to know the real strength behind a company which often called competitive advantage that distinguish great companies with those mediocre one. Without making proper analysis, valuation process might becoming much more hard for investors.
Step 4 : Valuing the business

A value investor tend to buy quality stock at a cheaper price. It is the main objectives of value investors. Therefore, after doing analysis over the fundamental part of the business, calculation of intrisic value is made using models, such as Discounted Cash Flow (DCF), Dividend Discount Model (DDM), Earning Power Valuation (EPV), and so on. It is hard to value a company without good earning predictability. Thus, valuing a stable busines with enough size of economic moat will be much more easy than a small high growth company.
Step 5 : Applying margin of safety

Another powerful tools for value investor is margin of safety, which was introduced by Benjamin Graham in its book, The Intelligent Investor. It is simply a gap between stock price and intrinsic value. The larger the gap, the better it is. in term of risk and future return. According to Ben Graham, the rule of this margin of safety is to eliminate the error made during calculation of intrinsic value.

It is the basic of investment process for many retail investor who'd practising value investing. Value investors believe finding a good quality company trade at cheap price is the best way of making money in stock market investment.

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