Value Investing : How to Pick Good Stocks in Indian Market

People usually ask market experts, how to pick up good stocks to invest in when it comes to Indian markets and Value investing. One of the easiest and probably best way of identifying the good stocks is to lookout for value investment opportunities meaning identifying the undervalued stocks and accordingly making positions in it. Good investing is all about getting more in return for what you have already paid. What you pay to own a business (or stock) is Price and what you get is Value. Price is certain and upfront. Value is a conjecture (albeit an intelligent one) and will unravel only over time in future. It is this contrast between price and value of a business (or stock), which leaves most market participants in a mystical, enthrall of price while holding the idea of value as mythical or treat it in confused derision. In simple terms, value is an estimate of present worth of a business, as judged from estimated income flows (or cash flows) that a business is likely to generate over its assessed lifetime.

Value = Present Value of All Future Cash Flows of a Business

When Value > Price, Investing = Value Investing and Stock is a Value Stock

Clearly, assessment of value will, therefore, depend upon the magnitude, certainty, timing pattern (early or late), volatility and longevity of those income flows. Judgment of these variables will depend upon the skills of the investor and the character of the business under consideration and the extent and accuracy of value will depend upon accuracy of judging these variables right. Successful investing will essentially call for judging the value right, setting the purchase price at a good discount (Margin of Safety) to the conjectured value, revisiting the equation time to time (more to confirm and convince oneself and less to act) and to enjoy, with patience, the gravy train of investing volatility!

Margin of Safety in Value Investing = Value - Price

As Charlie Munger would say "All intelligent investing is value investing - to acquire more than you are paying for Investing is where you find a few great companies and then sit on your ass." Investment is not a get-rich-quick scheme; it is not even a method of making the highest gains in the shortest possible time, though at times such outcomes also occur. But when these outcomes occur, they are merely milestones in the long-term process of wealth creation; the reverse also equally occurs when disproportionate amount of wealth can be eroded in a very short period of time. So over a period of time, the great game really is in navigating through these twists and turns with knowledge, with discipline, with wisdom and with a due understanding of principles to ensure that navigating is in correct direction, smooth, free from accidents and fruitful. Fundamentally, investing is simple, but not easy. Simple, because it is not difficult to understand the essential principles of investing. Essentially what creates value are really simple ideas. It is about identifying a large opportunity (which is rich in possibilities yet possesses existing, strong fecundity) that has earnings growth marshalled with a high degree of character, or, the value accretive growth rather than value destructive growth, that has growth with longevity, predictability and relative smoothness, ensuring that the character of management lets the value of a business be nurtured, protected and shared equitably and applying suitable simple mathematical equation to discount all that future into the present. Refer our article on how to select a stock for investment which specifically talks about these. This is what is at the innards of fundamentals of value investing. So investing as a concept is essentially simple in its core connotations, but it is not easy because apart from intellect, investing calls for wisdom, apart from knowledge it calls for discipline, and merely high IQ is no guarantee for great investment results, because doing it right, not only knowing it right, is as important. Even some of the best investors falter at doing it right rather than in knowing it right. More failures have occurred, even among the great investors, on account of the former rather than the latter. The difficult part is getting the right psychological traits, a disciplined behavioural make-up, a quiet sense of innate confidence (but not arrogance and rigidity), a sense of serenity in face of adverse market situation and an independent, curious mind. This is more likely to stand in good stead rather than only an ability to accurately predict every single quarter’s earnings for the next 20 quarters. In that sense, good value investing is a heady mix of a lovely, beauteous art and a very precise looking science. But it is not just one of the two. Science illuminates while the art is pregnant with possibilities and imbued with vivid imagination. Reality of investing lies between the two: It is neither a perfect science, like physics and mathematics, nor is it a complete art like painting, of ‘beauty in the eyes of the beholder’ kind. So, reality lies between the two. The art part is about understanding the quality and character of the business, of the people behind the business, appreciating what makes the business work and what makes it fail, what makes it robust and what makes it brittle. Understanding these traits is the art part. The art part also covers the wisdom, discipline, patience and independent mind aspects of value investing. Transcribing the art part into a tangible part and putting that tangible part into a working model including a mathematical one, is what the science part is. So, in some sense, where the art part ends, it feeds into the science part of the investing and then the science part seemingly conjures up the accurate answer. Depending upon their view point, many tend to see investing as completely capricious, arbitrary, a volatile game akin to gambling and almost unpredictable. And at the other extreme, there are some who reduce investing exercise to purely a mathematical model or a heuristic extension of crowd behaviour, completely divorced from the underlying fundamental ideas such as the quality of the business, the quality of management, size of opportunity, growth and valuation. But the reality is that the truth lies between the two. It is a judicious and beautiful confluence of the best ideas of art and the best that science can give. The resultant melting pot retains the beauty, on one hand, and elegant simplicity and mathematical rigour, on the other: investing is about that. It is about combining these variegated ideas and trying to gaze into the future. When you try to do so, it never really is or can be precise. You are leaping into the dark. It is a leap of faith which takes you there. The past does guide you because the past has helped you in understanding probable contours and shapes of conditions that you are likely to find in the future, but not always so. In final analysis staring into the future and getting there is akin to a leap of faith. No amount of advance preparation completely equips you to handle that probable future and value investing is really about this. It is about collating, assimilating and using all the insights about a business available at a point of time, analyzing it from diverse perspectives (some more akin to art while others closer to science, translating it all into a workable model (a melodious symphony rather than a cacophony of jutting out blocks of data points and information) and finally, forecasting of that future. When that process is done with integrity, intensity and intellect (in that order), the outcome is normally good. In good value investing, these 3is combined together produce a vivid image of beautiful future, and a more replicable future on a sustained basis. And the path to outstanding value creation. Lao Tzu says, “I have just three things to teach: simplicity, patience, compassion. These three are your greatest treasures.” In good value investing, read it as simplicity (of business), patience (of investor) and passion (for quality). Returns are tangible but the risk is not. Hence, the returns appear as real to the investors but risk appears as amorphous. The returns can be real, if and only if, they are earned by undertaking judicious and intelligent risk. Market and investors often behave as if the risk is unreal or an irrelevant trivia. But the truth is a polar opposite. This is where the concept of quality of return comes, as contradistinguished from, the quantum of returns. The ideas of certainty of growth vis-à-vis quantum of growth, quantum of growth vis-à-vis quality of growth and quality of growth vis-à-vis valuation, are the ideas which define the quality of returns or the idea of risk. In the similar vein, markets are not linear and hence, equity returns cannot be so. But investors often behave as if the markets are linear. They would like to see absolute returns when markets are falling and the relatively superior returns when markets are on ascendance. But absolute and relative returns are like two rabbits. When you try to catch the both simultaneously, you get neither in your hands. In value investing, it is worthwhile to follow the absolute returns. When done well on that count, the relative returns also usually follow. It is impossible to operate only on the good part of the market curve and always being able to avoid the bad one. Those incredible ‘timing’ skills are not well-endowed or proven; certainly, not with the most of the market participants. Value investing is indeed long-term even though it is not considered fashionable these days, to think or say so. But, that is the enduring truth of the equity investing. Fixed-income investing can, at best, maintain one’s wealth. It cannot multiply. Sometimes, it fails to even maintain the wealth, what with, the rigor of inflation and taxation. Good investing is really about creating future income streams, creating bigger wealth or value and really providing alternatives. In other words, it is not just about creating wealth but making wealth work for you rather than you working for wealth. That is at the heart of good value investing because it lets you be free from the tyrannies of the day- to-day engaging into mundane activities that one is compelled to. Many are good at creating wealth, but only a few are good at managing wealth, by successfully creating a running income stream from the wealth and expanding value further. To create greater wealth out of wealth is really the crux of value investing, so that it lets you do what you want to rather than what you have to.