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Value Investing: Styles and Techniques

Andrew is a self-educated business owner and entrepreneur with plenty of free advice (which is worth exactly what you pay for it!).


Value: Quality On Sale

Value investing involves finding a stock at a low price to buy, and then selling it at a significant profit at a later date (or never selling at all, in some cases). This loose definition leaves a lot of room for different styles and techniques, many of which are what people think of when the term "value investing" comes up. Here are a few of the key strategies and elements I've used in order to benefit from market volatility and low priced stocks over the last couple of years, and some ways you might be able to integrate these techniques into your own investing style.

1. Contrarianism: The Essence of Value Investing

Warren Buffett, often called the GOAT of value investing, has offered the advice that it's not wise to make investing decisions just because they're for or against what the crowd is doing at the moment. Instead, the goal is to calculate the value of a stock based on the intrinsic value of the underlying asset (usually a business), and then to divide by the number of shares to determine a fair stock price. Doing things just to be different isn't really the right approach, since the market is often approximately correct when assessing intrinsic value and creating a price for a stock. However, it's useful to remember that swimming with the school all the time won't allow for extraordinary results. Instead, it's important to determine the right time to do something the market isn't doing.

If a stock is incredibly popular and everyone is buying today, that means that everyone is driving the price up. While it still might be a great bargain, the more people who buy the stock, the less likely the stock is a good deal over time, broadly speaking. On the other hand, if more people are trying to sell right now and the price is dropping, you can frequently find great bargains if you just have the courage of your convictions.

I'd say that contrarianism alone—the ability to do what you think is intelligent regardless of what others are doing—has been the single biggest factor in my own investment success to date, and has been tremendously important in my personal and professional life to an enormous degree, allowing me to start my own businesses and to live the life I'm interested in living.

2. Cigar Butts

When Buffett's mentor, Benjamin Graham, wrote the landmark Security Analysis in 1934, he emphasized finding companies whose book value and underlying assets were actually worth more than the business was selling for on the market. This worked extremely well immediately after the Great Crash of 1929, since the emotion of fear took control, and people were often selling out of necessity instead of when they wanted to sell. A perfect storm of a need to meet margin calls (or pay bills) forced investors to sell some stocks for even less than the value of the cash and hard assets they had on hand, and Graham figured that if the business ever made any money, that was a nice bonus, reasoning that the assets could be sold for more than the stock was worth. This provided a generationally unique margin of safety for loads of businesses, and Graham backed up the truck.

When I first started buying lots of individual stocks at the very beginning of the pandemic, I found that a cigar butt approach was the right one for me. Deals were everywhere as panic-selling overwhelmed market sentiment, and I was able to find businesses that were 20, 30, and 40% off by just taking a look around, in spite of my very limited experience with using a discounted free cash flow model for company valuations. Contrarianism intersected with the cigar butt concept to create a wonderful buying opportunity for those with some cash. While today's market is arguably much more efficient than Graham's, and it's virtually impossible to find a pure-play cigar butt play where the assets are worth more than the business is selling for, there were nevertheless fantastic deals to be had for those on the lookout.


3. Dividend Growth Investing

One common value-oriented style of investing is dividend growth investing, which uses a simple concept: look for companies who pay a reliably growing dividend, and base your buying strategy around accumulating stock that pay you enough to live off in just dividends. While a dividend growth investor is still interested in getting the stock at the best price possible, what happens to the stock price after that isn't terribly important, since the plan isn't to sell the stock. In fact, if the stock price goes down, this means that the dividends, if reinvested, are going to be able to buy more of the business. This means that a dividend growth investor can remain confident in their original purchase even when the price drops, as long as the underlying fundamentals of the business look good. Dividend growth investors will often look to Dividend Aristocrats for a source of ideas: companies that have grown their dividend every year for 25 years or more. It's not a good idea to invest in a company just because they pay a high dividend, since they might be borrowing money to pay the dividend, or paying shareholders at the expense of reinvesting in the company. However, if you can find a company that does a good job of managing their free cash flow, has enough left over cash to reinvest in the business and doesn't have too much debt, you can often couple this strategy with contrarianism and cigar butts to find some amazing bargains that will continue to pay you for decades to come. The classic example of this strategy in action is when Buffett purchased more than a billion dollars in Coca-Cola stock in the 1980s. After the Black Monday crash in 1987 that caused the market to drop more than 20% in a single day, there were some amazing bargains on some great companies, and Buffett soon acted on KO (Coke). Because the dividends have consistently grown over time, Berkshire Hathaway now receives around $600 million a year in dividends, or more than half of their original investment. Imagine investing $100 in something now, and being paid more than $50 every single year (after some 30 years), while you still own the original asset. That's dividend growth investing at its finest.

Combining Techniques

Many companies that are still on a high growth trajectory, including Berkshire Hathaway itself, don't pay a dividend. This doesn't mean these companies can't be deep value plays as well, since most companies eventually do pay a dividend when they've reached whatever scale seems to be the maximum for them, and when management has exhausted the possibilities for capital expenditures—improvements that cost money, but help the business produce more profit over time—and decide that it's time to reward shareholders. For those that do, a combination of searching for cigar butts while using a contrarian mindset as needed, coupled with a steady, reliable dividend payout that grows over time, can be a very effective strategy for finding great bargains, and for reaching financial independence.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

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