Sunday 22 September 2013

How To Improve Your Value Investing Returns

Do your value shares go higher after you've sold? Here's what to do.
I'm a dyed-in-the-wool deep-value investor and have noticed two things about my strategy:
1. It works more often than it doesn't, and;
2. When it works well, the shares often go on to far greater things after I've sold.

Regarding the first point, remember; my strategy doesn't -- and can't -- work every time. In my experience, my approach simply works far more often than it doesn't, and I gradually come out well ahead.

As for the second point, we all have to learn to accept it as an inevitable part of being a bargain-value hunter. You will see recovery situations go on to greater things after you've seen the basic value 'come out'.

What to do
But there are a few actions to take that may help maximise your returns.

First off, if your bargain-value selection offers the best of all worlds; i.e. if there's some simultaneous excitement from a little growth potential, then be patient.

Often, value shares that are successful turnarounds become growth stories, or 'GARP' shares (growth at a reasonable price). In these situations, it may be wise to wait.

If you're unsure about what to do, but the basic value has come out, then selling enough to retain your original stake and letting the rest run for free can be a good tactic.

Selling too soon?
Personally, I usually sell too soon. You may have heard the phrase 'leave something for the next guy' from value investors. What they mean is that, when the basic value is out, it's out -- so let the future price do what it will. If it goes on to a 'fuller' value, then so be it.

You will rarely be able to buy at the bottom or sell at the top. Buying at a level you perceive as cheap and selling at a more reasonable value is what my deep-value approach is all about.

But I've realised that as a value investor, I can be too pessimistic about future prospects, just at the point of turnaround.

Run the winners longer
Consequently, I've resolved to run my winners longer. The value in deep-value shares can come out over days, weeks or months, but more usually it takes years. So a resolution to be patient and not to be tempted into too short term a profit, and to allow for a modicum of optimism should help not leave too much in for the next guy!

Don't stop loss
Stop-losses may be a useful tactic in certain situations. But on the whole, they don't work. They certainly aren't appropriate for value investing in my opinion. If an investment declines by 10% in a company which you perceived as undervalued, and there has been no fundamental change in the value metrics, then why would you sell?

The answer is that you wouldn't. If anything, have the courage to average down your purchase price.
A stop-loss can be helpful if you think the shares have further to go as they begin to enjoy a growth rating.

Be sure about your safety margin
In order to be confident about averaging down, though, you need to be sure about your safety margin.
The three most important word's in Benjamin Graham's lexicon were 'margin of safety' -- the price at which a share can be bought with minimal downside risk.

A substantial margin of safety exists when a share is available at a big discount to its 'fair' value. By building a substantial margin of safety into your investments on the basis of well-researched factual information, you will help protect the downside.

Being as sure as you can be about the safety margin in the first place will give you the confidence to average down. You will also have the information you need to set something like a fair price target, however long it takes for that price to be reached.
But even with this strategy, there will still be ones that go wrong.

Don't try to time it
Don't try to time the market. There's an army of people out there with endless data. Why would you know better?
Instead, try to find companies trading at historically low prices and on historically low ratings with strong balance sheets and wait for the value to come out.
As Ben Graham said "[investors] … should rarely buy [shares] when their short-term prospects look bright."

Don't over trade
And finally, a reluctance to trade will help you maximise your value investing returns. Remember, trading costs and most frequent traders lose money.

By David Holding
http://www.fool.co.uk

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