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7/23/2019 Ranchi_Lecture on Value Investing
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INTRODUCTION TO VALUE INVESTINGIIM Ranchi
March 16, 2015
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“We think the very term “value
investing” is redundant. What is“investing” if it is not the act of seeking
value at least sufficient to justify the
amount paid. Consciously paying more
for a stock than its calculated value —
in the hope that it can soon be sold for
a still-higher price — should be labeled
speculation (which is neither illegal,
immoral nor — in our view —
financially fattening).” — Warren Buffett
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“An investment operation isone which upon thorough
analysis promises safety of
principal and a satisfactory
return. Operations not meeting
these requirements are
speculative.” — Ben Graham
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Three Key Principles of
Investing
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Principle # 1: “Investor should
look at stocks as part
ownership of a business.”
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Principle # 2: “Investors should
look at market fluctuations in
terms of Graham’s “Mr.
Market” example and “make
them your friend rather than your enemy by essentially
profiting from folly rather than
participating in it.”
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Principle # 3: “The three mostimportant words in investing
are “margin of safety”, which
means “always building a
15,000 pound bridge if you’re
going to be driving 10,000
pound trucks across it.”
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“When you build a bridge, you insist it can carry 15,000
pounds, but you only drive 10,000-pound trucks acrossit. And that same principle works in investing.” —
Warren Buffett
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The Idea of “Margin of Safety” is based on the idea of
Redundancy in Engineering
http://en.wikipedia.org/wiki/Redundancy_(engineering)
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Sources of Margin of Safety
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Margin of Safety From A Low Price
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In American roulette there are 38 slotsnumbered 1-36, 0, and 00. Pay-out is 35:1
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If you bet Re 1 on your lucky # 8 and if theball lands on # 8, you win Rs 35, otherwise you
lose Re 1.
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You wager Rs 1,000 on a single number, say number 7.Probability of ball landing on 7 = 1/38 = 2.63%.Probability of not landing on 7 = 37/38 = 97.37%
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Event Payoff Probability Expected Value
Ball lands on 7 36,000 2.63% 947.37
Ball does not land on 7 0 97.37% 0
947.37
Amount Bet -1,000
NPV -52.63
Suppose you bet Rs 1000/38 or Rs 26.32 on each of the 38
numbers to “spread your risk”
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Event Payoff Probability Expected Value
Ball will land on one ofyour numbers
947.37 100% 947.37
Amount Bet -1,000
NPV -52.63
Lesson: Diversification does not work when Margin of Safety isabsent.
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Each bet has an expectancy of a profit even though
some will inevitably result in a loss
Wide diversification
Cap on Max Bet
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Four Businesses
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Some Principles
Principle # 1: Assets are worth more than book value
when they are expected to earn a return on capitalemployed which is more than market rates of return.
And Vice Versa.
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Some Principles
Principle # 2: Assets lodged in the hands of a manager
who thinks and acts in the interests of the owners areworth more than identical assets lodged in the hands of
a self-interested manager.
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Some Principles
Principle # 3: All growth is not good. There is good
growth and there is bad growth. Good growth creates
value. Bad growth destroys it.
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Some Principles
Principle # 4: Quality matters.
“Leaving the question of price aside, the best business
to own is one that over an extended period can employ
large amounts of incremental capital at very high rates
of return. The worst business to own is one that must,
or will, do the opposite - that is, consistently employ
ever-greater amounts of capital at very low rates ofreturn.” — Warren Buffett
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Some Principles
Principle # 4: Quality matters.
“The worst business of all is the one that grows a lot,where you’re forced to grow just to stay in the game at
all and where you’re re-investing the capital at a very
low rate of return.” — Warren Buffett
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Some Principles
Principle # 4: Quality matters.
"Time is the friend of the wonderful business, the
enemy of the mediocre.”
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"If a business earns 18% on
capital over twenty or thirty
years, even if you pay an
expensive looking price, you'll
end up with one hell of a
result." — Charlie Munger
Some Principles
Principle # 4: Quality matters.
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Some Principles
Principle # 5: Price Changes Everything
“Leaving the question of price aside, the best business
to own is one that over an extended period can employ
large amounts of incremental capital at very high rates
of return. The worst business to own is one that must,
or will, do the opposite - that is, consistently employ
ever-greater amounts of capital at very low rates ofreturn.” — Warren Buffett
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(Compound Interest + Longevity) + Reasonable price =Wealth Creation
Key Questions:
What produces (Compound Interest + Longevity)?
What produces Reasonable Price?
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Various Sources of Moat
Intangible Assets
Customer Switching Costs
Network Effects
Low Cost AdvantageNiche
Corporate Culture
Reputation
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It is useful to think about moats from the perspective
of customers as well as competitors
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(Compound Interest + Longevity) + Reasonable price= Wealth Creation
Key Questions:
What produces (Compound Interest + Longevity)?
What produces Reasonable Price?
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“The capital asset pricing
model type reasoning with its
different rates of risk adjusted
returns and the like, weconsider, it nonsense.”
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But we think it’s also nonsense to
get into situations – or to try and
evaluate situations – where we
don’t have any conviction to speak
of as to what the future is going to
look-like. I don’t think that you cancompensate for that by having a
higher discount rate and saying,
“Well, it’s riskier. And I don’t really
know what’s going to happen.Therefore, I’ll apply a higher
discount rate."
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SUMMARY
All investing is value investing but there are three key principlesto follow. (1) Business Underneath Every Stock; (2) Mr. Marketcan be Wrong; and Margin of Safety is Important.
A Fundamental Principle: (Compound Interest + Longevity) +Reasonable price = Wealth Creation
Investors Should Spend Time Understanding the Above Equation.
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– Sanjay Bakshi
Thank You