The Secret Behind Macroeconomics and Value Investing
By now we have looked at value investing and what it is, how to determine the intrinsic value of any stock, what the margin of safety is and how to apply it properly, what types of stocks to look for and what to avoid. Still, there is one more thing to consider. Macroeconomics.
I am a firm believer that as an investor one should understand Macroeconomic factors prior to making any sort of an investment. While not an important part of an equation for short term traders, it is an incredibly important factor for most value investors who’s investment time frame is oftentimes counted in years. A miscalculation on macroeconomic front could have severe consequences on your overall investment. Let me give you an example.
For simplicity sake and without going into too many details, let’s assume that you have looked into buying a home building stock in early 2007. After doing a lot of research and valuation work you cannot believe your eyes. For some reason the stock is selling at 60% discount to its Intrinsic Value and the growth rate remains over 20% on all fronts. Everyone is excited about the real estate market and your work shows that this stock should at least double over the next 12 months. Based on your work you are 100% confident that this particular stock is a Rocket Ship. You can’t believe how lucky you are as you begin drool just thinking about how much money you are going to make.
Yet, you have just missed an incredibly important point that only macroeconomic analysis can provide. You have missed the fact that the overall US Economy and the Real Estate/Financial industry in particular are in a giant bubble that is about to blow up. You have missed the point that when that bubble does blow up it will take the entire economy and the real estate/financial sector in particular down with it. Big time. Further, when that happens your significantly undervalued home builder stock price is likely to collapse even more because it is directly tied up into that sector.
That is exactly what happened. Even though home building stocks were already down significantly at the start of 2007 (indicating substantial value), they proceeded to decline even further (50-80% further) when the credit bubble of 2007-2009 finally blew up.
Point being, looking at the company or the sector alone, is not good enough. You must have an overview of the overall economic environment in order to avoid situations as described above. A value investor with a clear macroeconomic point of view would have never even looked at home builders in 2007. Well, maybe from the SHORT side, but that’s about it. Bottom line is, any good investor worth his salt should always be aware of where we are in the economic cycle. That is where macroeconomic analysis comes in.
Do not despair. You do not need a fancy degree from a business school to understand macroeconomics. It is probably best that you don’t have one. That way you have an open mind to see how easy and straight forward this analysis can be.
First, you must understand something very important. Do not pay any attention to the financial media (or media in general) and/or professors of economics and/or the economists themselves. All of that data and all of their fancy economic models are nothing more than garbage. If their models worked, these people would be on Wall Street making millions of dollars instead of playing with their numbers and/or teaching others.
Let’s make it as simple as possible when it comes to economists with their own interest on the line. Simply ignore ALL of them. Don’t give them even a split second of your attention.
To be continued…..
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