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What Everyone Is Ought To Know About Value Investing

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If you have spent any time in financial markets, you probably already know what Value Investing is. If you are new to investing, Value Investing is probably the easiest investment style to understand and apply towards your own investment purposes.  Also, while debatable, some very successful investors have proven that Value Investing is one of the best ways to approach financial markets over the long term.  Let me first illustrate what Value Investing is with a real world example.

Imagine that you are strolling through your local mall in the middle of July.  The sun is scorching hot and you are just trying to stay cool.  After your 3rd Caramel Frappuccino you decide to check out a nearby sports superstore. Shortly after you walk in you see something and you can’t believe your eyes.  The snowboarding jacket you have always wanted, but were never able to afford is on sale.  And not just any kind of a sale. It is a seasonal liquidation sale. Typically selling at close to $250 during the winter season it is now just $19.99.   

You can’t believe how lucky you are. You check the jacket to make sure there is no big gaping hole in the back of it. Nope, everything looks fine. The size is just right. All zippers work and it’s the color you want. You are beyond excited. You found exactly what you wanted at over 90% discount to what it is really worth.  The timing is not perfect and you can’t use it for the next 6 months, but you know with 100% confidence that you have found a deal of a life time. In 6 months this jacket will be selling at $200-250 again. Without a second of hesitation you take out your wallet and head towards the register.

Value Investing is just like that.

Except, instead of a jacket you are buying shares (or other financial instruments) in publicly traded companies. Basically, you do a lot of fundamental research to find companies that are selling well below their intrinsic or real value and then proceed to buy them at a significant discount. Typically 50-99% discount. The bigger the discount you can obtain the bigger your margin of safety is.  In fact, margin of safety is one of the most important concepts when it comes to Value Investing.

Margin of safety is there to protect your capital. The theory suggest that if you buy stocks at deep enough discounts to their intrinsic value you have an automatic safety net built in. After all, no fundamental research can be 100% accurate and you need something to limit your downside risk. In such a case you are unlikely to lose a lot of money on your stock trade/investment because your investment is unlikely do decline that much further. Remember, it is already very cheap. 

In essences you are buying $1 bills for $0.50 cents or less.  Over time these assets “should” appreciate back to $1 to reflect their true value. Providing you with a large return on your investment while minimizing risk. Yet, as with anything, there are numerous issues associated with value investing. I will cover them in greater detail over the next few chapters.

For now, let me quickly summarize value investing in a five easy steps.

  1. Do a lot of fundamental research to find deeply discounted stocks or other assets.
  2. Buy such bargains or stocks at a significant discount to their intrinsic value. Typically a 50% or more discount is required. By buying at a significant discount you create a margin of safety.  
  3. Margin of safety is your best friend. Maximize it. It protects your capital by limiting the downside.
  4. Patiently wait for asset appreciation to reflect its true value. Such periods can range from days to years.  
  5. Watch your investment like a hawk by constantly updating your fundamental research. Should any developments alter your original investment thesis, you should re-evaluate your investment decision. 

That about covers it. 

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Becoming An Investor, Part 3

Now, I understand that you might be skeptical of the statement above.  Yet, I ask you to keep an open mind and hold judgment until you finish this book.  Just remember, if I was to suggest 500 years ago that the earth was round or that the sun and not the earth was the center of our solar system,  I would probably be burned at the stake.  As Albert Einstein so famously said “God Does Not Play Dice”, meaning the universe presents us with the perfect order in all things. It is only the stuff that we do not yet understand that is viewed as random or volatile.

By March of 2006 I have made a huge break though in my mathematical work. So much so that I have led myself to believe that I finally broke the “stock market code”.  By this point my work was so well researched and accurate that I truly thought that I have figured it out. I was on could 9. Finally, it was my chance to shine.  That was the final piece to the puzzle I was searching for. I would be an unstoppable force in financial markets now, it was only a matter of time before I would be a billionaire.

By May of 2006 and after some additional confirmation work I was ready to go. In hindsight, what I did next was beyond idiotic. I threw out my value investing book, I threw out all of my rules and I threw out any type of rational thinking along with it. I was ready to be a trader now. I was going to make a ridiculous amount of money 

The next 20-30 trading days were amazing. My work has allowed me to pick 90-95% of significant tops and bottoms with hourly resolution. Meaning I was able to pick almost exact tops and bottoms sometimes in advance and sometimes minutes or so after they have happened.  It was a fascinating time and by the time this period ended I have accrued close to $500,000 in profit.  

Yet, for some reason that wasn’t enough. I was blinded by greed.  I wanted to make more money as I was only 3 years away from being 30 years old.  Beaming with confidence and desire to make an obscene amount of money I became even more aggressive and careless. Not only with my own money, but with the money of my clients and other funds I was managing at the time.

In June of 2006, on the day of the  FED interest rates decision my work showed a powerful move to the downside.  It didn’t matter to me what the decision was, my work clearly indicated a significant move down. Blinded by the accuracy of my work in the past, by the greed running through my blood and by my oversized ego I bet the house on the stupidest trade of my life.

I took all of my money and a large portion of my clients money to buy as many Short Term PUT Options as I could. If my work was to be right I would make a huge amount of money. If it was wrong, well……that was impossible according to my mind.  (If you are not familiar, put options allow you to leverage your trade and make or lose a lot more money faster than you would be able to do investing in an underlying security).

I was right about one thing. There was a powerful high energy move that day, but to the upside.

Long story short, I started the day as a self made multi millionaire hedge fund manager and ended it as broke bum. Thus far that day remains the lowest point of my life. It was so bad that I was literally 10 seconds away from blowing my brains out. If you would like to learn more about this experience I suggest you visit my other website,  LastSpartan.com and search for the first article on that site titled, I Want To Die Today, I Think I Will Blow My Brains Out.

When the day ended I was broke. Not only financially, but spiritually, mentally and in every other way you can think of.  At least for the time being I was finished as an investor. I lost all interest in financial markets.  I shut down my fund and returned capital to my investors. They lost very little, if anything. I used my own capital to prevent their losses. I couldn’t stand to even look at financial markets or my research. I was too devastated and mentally destroyed. I put everything away and moved on to the next chapter of my life.

As time went by my thirst for financial markets came back. My pain went away and by mid 2013 I was ready once again.

I am back baby!!!

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Becoming An Investor, Part 2

As a side point, you do not really need that much money to start a hedge fund.  While most people believe you need millions to start one, it is possible to get away with spending as little as $200 to $500 on all of the above points. You do need to have capital to invest, but the overall structure of the hedge fund is fairly easy and inexpensive to setup. If you do have questions about setting one up, please don’t hesitate to contact me so I can point you in the right direction.

Now, with money sitting in my brokerage account and my fingers getting itchy I decided to concentrate on the following Value Investment Strategy.

  1. Find substantially undervalued stocks (companies) selling at a significant discount to their intrinsic value.
  2. Such companies must either be growing rapidly, about to grow rapidly or have some sort of a catalyst in the works to release value in point #1.
  3. Concentration. These types of investments are hard to find.  As such, you should concentrate on having only 3-5 stocks in your portfolio. This is what Warren Buffett does as well. Diversification is a myth.  
  4. Do an enormous amount of fundamental research to confirm points 1 through 3.
  5. Watch your investments like a hawk in case of any change.

The first three years were amazing.  While the DOW remained basically flat in net terms during this time (2002-2004), my fund returned an astounding +149.75% net of fees.  I was on fire, I could do no wrong.  Most of the things I touched turned to gold.  

I was starting to get more clients, more money and making contacts in the industry.  I was now making fairly good money, but I was getting restless.  I was growing sick and tired of the strategy above. It was not exciting enough for me. There were only a few stocks/companies that matched my criteria and after a while I knew everything there is to know about them.  There is only so many times you can look at the balance sheet of any given company before getting bored out of your mind

Yet, I couldn’t sit still. I knew there had to be a better way to invest. A more advanced way. One of the major problems with value investing is timing. While you can identify a substantially undervalued asset, it might take years before its value is realized. You don’t know when it is going to happen.  It might be tomorrow it might be 2.7 years from today. In the meantime you have your investors calling you and questioning everything that you do.

The competition for capital in the investment industry is fierce.  While I am telling my clients about the balance sheet, fundamentals, valuations and why this company should appreciate significantly given enough time, their Lehman Brothers broker is screaming how NOW is a “Generational Buying Opportunity.”  I think they teach that phrase in the stock broker school.

I shouldn’t complain, I had great and understanding clients. Yet, I wasn’t naive, all they wanted from me is performance. If I couldn’t outperform this quarter or the next one, they would be gone.

At that time it was easy for me to figure out WHAT will happen, but next to impossible to try and figure out WHEN it will happen.  As such I shifted my research work on TIMING. I wanted to see if it was possible. I have studied everything I could put my hands on.  Technical analysis, cycle analysis, planetary movements, physics, mathematics, various other sciences and even witchcraft.  At the end of the day and after a tremendous amount of work I found what I was looking for.

Let me state this in no uncertain terms as the whole premise of this book relies on this statement.

Yes, it is absolutely possible to time the markets and/or individual stocks. I have proven that fact to my entire satisfaction.  Math doesn’t lie.  

To be continued tomorrow…….

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Becoming An Investor

Timed Value Part 1. 

I  became interested in financial markets when I first learned about them at the age of 16. Growing up in Russia we had no financial markets. We had a controlled economy where there was no such thing as stocks, bonds, private enterprise or investors. Everything was controlled by the government. Everyone lived in the same type of housing, wore the same type of shoes, the same coat and the same type of  jeans (if you could get a pair). It was a bizarre world indeed.

Shortly after coming to American at the age of 15 I because fascinated with the stock market for one simple reason. I wanted to be rich. I wanted to be a filthy rich billionaire by the age of 30.  No matter how naive that goal looks now, that was my only dream at the time.  Even at that age I understood that if I want to be really rich, one way or another, I have to participate in financial markets. I can either be an investor or build a company and then take it public or build/sell a large private company.  These are the only ways to get into the Billionaire club.

I started studying the market and how it works.  I concentrated on the people who have seen huge success in the stock market.  Of course Warren Buffett stood out as the most successful one, but I did study others as well. People like Peter Lynch,  Jim Rogers, George Soros, Philip Fisher,  Benjamin Graham and many others.

For some reason I really clicked with Value Investing and what Warren Buffett was doing. It made a lot more sense to me than investing in growth or speculating based on other factors such as technical analysis, trends, timing, etc….  It was really simple.  Find an undervalued asset, buy it at a significant discount to its intrinsic value (company value),  sit around and wait for that stock to appreciate over time to reflect  its true value.  Sounds easy enough. Anyone can do that and get rich.  Or so I thought.

Two years into my college education I have decided to drop out of my Pre Med Major (I wanted to be a brain surgeon but wasn’t smart enough) and switched to finance.  By that point I knew that I wanted to participate in financial markets. The degree itself wasn’t very useful.  We rarely talked about how to make money in the stock market.  The courses were mostly filled with useless formulas and academic equations that have no place in the real world.

Soon after graduation I felt that I was ready.  Yet, finding a job working in financial markets in San Diego in 2001 was nearly impossible. The tech bubble has burst and there were very few jobs available. I was offered a few financial product  sales jobs, but I decided to strike out on my own. So, on January 1, 2002 at the tender age of 22, I naturally started my own hedge fund. 

Without a penny to my name, I was able to scrape enough money together to register the business, do some legal stuff, pass needed exams, open a bank account and a brokerage account. After naming the fund Dvorkin Investments, LP (what else) I was ready to go. All I needed now is some capital to invest. After some negotiations with my parents I was able to secure them as my first clients.  With $10,000 now sitting in my brokerage account I was ready to rock and roll. Out of the way everyone I am on my way to becoming a billionaire.  

To be continued tomorrow…..

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I Am Calling For A Real Estate Top Here

Daily Ticker Writes: “The Party Is Over” for Housing — and Bank Earnings:

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Market watchers are increasingly concerned about recent weakness in the financial sector.

In a related development, technical analyst J.C. Parets of All-Star Charts has expressed concern about a potential topping pattern in JPMorgan while blogger ChessNWine identified a bearish pattern in Goldman Sachs “with potentially devastating ramifications to financials.”

“The party is over” for refinancing activity while a weak job market and flat consumer incomes are preventing a pickup in purchase activity, Whalen says. “Structural reasons, apart from rates [mean] you’re going to see a real tail-off in demand” for mortgages.

Read The Rest Of The Article Here

Those following the Real Estate market should be very concerned with the data coming out. It is showing that the top is very near or has already been set. If you actively participate in the real estate market this is an important issue to watch.  Let’s look at some bullet points.

  • Refinancing is down substantially.
  • Banks are shutting down/moving their mortgage operations and firing tens of thousands of people. They expect a substantially lower volume going forward.
  • Interest rates are much higher from a year ago and are likely to rise further.  
  • Rapid speculation in various markets. Las Vegas and So.Cal.
  • Banks are lowering their earnings due to much lower volumes.
  • Bearish technical patters are starting to develop in real estate and financial stocks.
  • Both the US Economy and the stock market are facing severe declines.
  • Please see other factors in my previous posts CLICK HERE

These are just a few, but it gives us enough information to paint a clear picture. Real estate is toast. The rebound that we have experienced over the last 2-3 years is now over (or nearly over).  While various local markets might top at different times, the overall real estate market is topping right now and should start its decline shortly.

Therefore, I feel confident enough to call for a real estate market top right here and now.  I am going on the record here. Even if I am a few months early I believe it is a good call.

“I never buy at the bottom and I always sell too soon.” – Baron Rothschild

If you are in, now is a good time to get out.  

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Hello Beijing, Washington Here. Listen, Do We Have Your Permission To Shut Down Our Government?

Reuters Writes: Analysis: Default or not, Asia a hostage to U.S. debt

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SEOUL/BEIJING (Reuters) – Unless the U.S. Congress settles a political showdown to raise the country’s debt ceiling in coming weeks, it will be left on the edge of an unprecedented default. But America’s main creditors in Asia may be the least of its worries.

The creditors – China, Japan and other Asian governments – have a hoard of U.S. Treasuries in their $5 trillion cache of foreign exchange reserves, the equivalent of almost a third of U.S. gross domestic product.

Despite having so much at stake as bond prices lurch violently, they are not about to do anything more than minor tweaking of their portfolios.

“But the expected returns from bond investment will fall greatly in the future,” Choo said. “How to deal with this structural change in investment environment is what all the central banks are agonizing over.”

U.S. bond yields have already risen more than 100 basis points since May, when the Fed first indicated it is going to cut back on its $85 billion per month asset purchases.

Read The Rest Of The Article Here

With a lot of theatrics going on in Washington, I do not believe Asian countries debt holders should worry about any sort of a default. At the end of the day, the US Government will pay on all of its obligations.

The biggest story here is not the shut down or the potential default, but the eroding confidence in the US Economic and political system.  The US politicians are acting like a bunch of 5 year olds on the playground (I guess no surprise there) while the rest of the world is watching. Why is this important? Very simple.

Not a good idea when you OWN $16.5 TRILLION 

If Asian creditors see this continue, they could (well, they should) in theory start reducing their US Debt exposure.  As that happens, yields would spike leading to a significant stock market and the US Economic decline. So, as the US Politicians aimlessly point fingers at each other while scarring the rest of the American people with Economic Armageddon,  our creditors are watching very closely. That’s what we should be really worried about. 

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America Will Eat Its Own Young

Business Insider Writes: Go-Nowhere Generation: Why Young People Are Stuck

drunk americans 

At a time when young Americans have never been more connected, they sure have gotten used to staying put.

The chance that 20-somethings would pack up and move to another state has fallen by more than 40% since the 1980s, according to U.S. Census data. At the same time, young people are increasingly choosing to move back home with their parents and, in some cases, never leave in the first place.

“Sometime in the past 30 years, someone has hit the brakes and Americans — particularly young Americans — have become risk-averse and sedentary ,” Todd G. Buchholz, author of “Rush: Why You Need and Love the Rat Race,” wrote in a controversial NY Times piece. ” Today’s generation is literally going nowhere. This  is the Occupy movement we should really be worried about.” 

Read The Rest Of The Article Here

Interesting article and I highly recommend everyone to read it.

I am not sure what to think of it.  Is American youth staying put due to latest technological advances that make it easier to communicate -OR-  have years of what I call “You Are The Best” generation and narcissism finally catching up to the American youth?

Are they too scared to leave their homes and face failure? If so, that is not a good trend for the health of the US Economy or the Nation overall. It is too early to say, but it is definitely a good trend to watch closely.

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Derailed Recovery

Forbes Writes: Mixed Messages For Bernanke Shouldn’t Derail QE Taper, Despite Lower Inflation

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As investors intensify their scrutiny of the Federal Reserve, economic indicators continue to send out mixed messages.  Inflation, as measured by the CPI, eased once again in August, according to theBureau of Labor Statistics, but remains relatively anchored, indicating Chairman Ben Bernankeand the FOMC could be closer to tapering quantitative easing, possibly on Thursday.

Mixed economic indicators continue to baffle a market that seems to have prepared for a reduction in the Fed’s supportive asset purchases, or QE.  Inflation, one of the main monetary factors observed by Fed officials, has been consistently low, yet not alarmingly so.  Over the past 12-months, CPI is up a meager 1.5%, down from 2% in July.

While the U.S. economy has remained relatively resilient, with GDP growing 2.5% in the second quarter, it is by no means out of the woods, as the labor market remains weak and financial conditions have tightened, particularly in mortgage markets which are closely scrutinized by the Fed, Goldman Sachs’ economics research team said.

The Federal Reserve, which is in the midst of a transitional period as Chairman Bernanke’s term expires early in 2014, is looking to reduce its level of asset purchases to avoid inflating asset bubbles and creating further imbalances.  Investors are looking for the FOMC to cut down on QE on Thursday, possibly reducing asset purchases by $5 to $10 billion to $75 to $80 billion a month.

In order to continue with the plan laid out by Bernanke in his previous conference, in which the Fed expects QE to end by mid-2014, Fed officials will want to see a pickup in inflation that strengthens their view that deflation is not a looming problem.  “While the stabilization in core [CPI] is likely sufficient for Fed officials to start the tapering process [Thursday], officials are counting on some acceleration in coming quarters,” explained Jim O’Sullivan, chief economist at High Frequency Economics, who added, “such acceleration will likely be needed for a full wind-down of QE and will almost certainly be needed before the tightening cycle begins.”

Read The Rest Of The Article Here

A very good overall summary of the existing US Economic and Financial Market state that comes to a wrong conclusion.  It somehow assumes that the Fed and US Government are in control of the US Economy and will direct it into whatever direction they wish to improve existing metrics and to maintain the course.

However, that is a fools assumption.  They are not in control of anything. The 2007-2009 meltdown was a clear example of that. No matter what they have tried,  the market kept going down until it hit its March 2009 technical bottom and reversed itself. If that doesn’t convince you of the fact that they have no control, nothing will.

Now, the article states that the policies the Fed has instituted are design to avoid future financial asset bubbles and volatility associated with it. What it fails to mention is that we are ALREADY in the largest financial credit bubble of all time. Bigger than 2007.  And guess what, it was done on purpose by the Fed to avoid a deeper recession.

As Fed cut back on QE, interest rates will go up and in doing so will collapse the real estate market, the stock market and the overall economy.  Oh, I forgot to mention something. It will not be fast and will most likely take years. However, the process itself has already started. Get your affairs in order.  

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US Auto Sales Are About To Crash

Bloomberg Writes: American Auto Sales Seen at Annual 16 Million With Profit

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The U.S. auto market is poised for a fifth straight year of growth for just the second time since World War II. The recovery from the recession has been so robust that the debate is now whether sales will reach 2000’s record levels — and whether that would even be a good thing. 

Deliveries of new cars and light trucks may rise to 16.1 million next year, the average estimate of 13 analysts in a survey by Bloomberg News. That’s about 500,000 more vehicles than automakers are on pace to sell this year and while it’s within reach of 2007’s 16.15 million, it’s well short of the 17.4 million peak.

Since the annualized pace of auto deliveries in August exceeded 16 million for the first time in six years, analysts have been looking back at the last time sales were so brisk. Six years ago, while sales were still above 16 million, Detroit was losing billions, saddled with high costs and poor cars.

“It’s not just the number 16 that’s amazing,” George Magliano, chief economist for IHS Automotive, said by telephone. “It’s the fact that it’s coming effortlessly. We’re not dumping cars and trucks into the fleets. We’re not using humungous incentives to move them. It’s a reflection of people’s willingness to buy and the strength of the product out there.”

Read The Rest Of The Article Here

Listen, I don’t know why this was so difficult to understand.  All improvements in the US Economy over the last 5 years were caused by a massive infusion of credit and money supply at ridiculously low interest rate. Nothing else. The recovery is an artificial one and is coming to an end.  

It is not different for auto sales. As a matter of fact, today it easier to get an auto loan than to get a doctor’s appointment. I am once again hearing things like, “If you got a pulse, you will get an auto loan”. Well, that’s great, but didn’t we already see this in the real estate sector just 7 years ago. We all know how that ended.

It’s essentially the same situation with car sales. The recovery from the recession has NOT been robust as the article states. This is a simple matter of a Financial bubble that the FED has once again blown. It is massive and it will blow up. When it does, car sales will collapse along with everything else.  

It will be great to be a used (excuse me, “pre-owned”) car buyer over the next few years with all of the repossessions that are surely to flood the market. 

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46.5 Million Americans Live In Poverty. Blame The US Government.

Associated Press Writes: Poverty rate stuck at 15 percent; record 46.5 million

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WASHINGTON — The nation’s poverty rate remained stuck at 15 percent last year despite America’s slowly reviving economy, a discouraging lack of improvement for the record 46.5 million poor and an unwelcome benchmark for President Barack Obama’s recovery plans. 

More than 1 in 7 Americans were living in poverty, not statistically different from the 46.2 million of 2011 and the sixth straight year the rate had failed to improve, the Census Bureau reported Tuesday. Median income for the nation’s households was $51,017, also unchanged from the previous year after two consecutive annual declines, while the share of people without health insurance did improve but only a bit, from 15.7 percent to 15.4 percent.

“We’re in the doldrums, with high poverty and inequality as the new normal for the foreseeable future,” said Timothy Smeeding, an economics professor at the University of Wisconsin-Madison who specializes in income inequality. “The fact we’ve seen no real recovery in employment and wages means we’ve just flatlined.”

Read The Rest Of The Article Here

I am not sure why anyone would be surprised with this. Over the  last decade US has instituted policies that basically benefit the rich or those involved in the financial sector at the cost of the middle class and the poor.

Cutting interest rates close to ZERO basically provides an unlimited money supply to those already in power or with money and allows them to speculate on financial or real estate assets without risk. That in turn makes them even more money.  Since the working poor don’t have such an access they are left behind by default. I don’t see anything in the US Economic policy that would change that any time soon.

Weather this is an economic, social or political issue is for you to decide. However, I would just mention that the US Economy cannot perform well if so many people are left behind. It might work for a while, but eventually it catches up to the rest of the US Financial system.  In this case, as the US Financial Asset Bubble (the bubble that is basically artificially keeping the US Economy afloat) implodes, there will be hell to pay. 

Maybe it’s a good idea for someone to open a Guillotine manufacturing company in the US. 

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