Thus far value investing has been a perfect investment vehicle. After all, what’s not to like. It steers you to buy wonderful businesses at highly discounted prices. That in itself minimizes your risk by creating a margin of safety while maximizing your return potential, creating a highly desirable low risk and high return type of an investment scenario.
At the same time Value Investing is not perfect. While there is a number of shortcomings associated with Value Investing, the most important one from our vantage point is the issue of “TIMING”. Please allow me to explain.
Let’s assume that you have been able to find a value stock of your dreams. Let’s imagine for a second that it falls into either a Waking Beast or a Rocket Ship category. Let’s further assume that the company is clothe retailer who’s stock is selling at 70% discount to it’s Intrinsic Value. The company suffered over the last couple of years due to various financial and merchandising issues. Same store sales are down 50% over the last 3 years and the company recently closed 25 underperforming stores. As a result the stock price has collapsed over 80% in the last 2 years.
At the same time your in-depth fundamental research shows that things are about to get better. The company recently restructured and brought on a new management team with an excellent track record. That is already being evident in the companies same store sales and improved cash flow. The merchandise is hot again and the company is also getting ready to start opening up a lot of new stores over the next 2 years. Based on your research and calculations the stock price should be at least double of where it is today and much higher if the company continues to perform well. Overall, it’s a wonderful buying opportunity that you believe will make you a lot of money.
Yet, for some reason the stock price hasn’t moved to the upside yet. The market hasn’t yet recognized the change that you see and hasn’t yet re-priced the stock. If anything, the stock price continues to go down, on average losing about 1% per month. The question is….why?
The answer has to do with TIMING. This has always been an issue with value investing. While we can identify significantly undervalued assets, thus far no one has been able to determine WHEN these assets will begin to appreciate again to reflect their true intrinsic value. As today’s value investors very well know such appreciation can happen at any time. As in the example above the stock price can start climbing tomorrow, a few months from now, a year from now or five years from now. It can also never climb again.
The old value investing mantra states that such a scenario is fine and that it shouldn’t matter. For as long as you buy a stock at a significant discount to its intrinsic value and hold it until the stock reaches that value or appreciates significantly enough, you should be fine. Yes, it could take a long time but your eventual capital gain and lower risk profile should make up for your “unknown holding period”.
I respectfully disagree. (To be continued…)
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