Investing In Practice

Intrinsic Value Investing offers a clear course of action to preserve and grow capital.

Calculating intrinsic value
Assessing the intrinsic value of a business is not an easy task, and is as much an art as a science. Intrinsic value is not a precise number: the value of a business, even when not overly complex, depends on many factors. The aim is therefore to attain a range of reasonable values, depending on various assessment methods and on the variability of each factor impacting the business valuation.

Furthermore, intrinsic values are not static and need to be regularly reviewed. Their range may be affected by changes in economic or political circumstances as well as by business and technological developments, and, so, needs to be rigorously monitored.

Arriving at a reasonable estimate of intrinsic value is the key to the success of the investment. An understanding of the quality of the evaluation, or the level of confidence which can be attached to it, is also helpful in determining the amount of capital it will be reasonable to allocate to the investment.

Purchasing securities
After having carefully determined its Intrinsic Value, Intrinsic Value investors start buying the security they seek as soon as its Margin of Safety becomes sufficient, often at a time when its price is declining and its offer is unconstrained. If the price of the security declines further, they will continue to build their position, averaging down its cost and thereby increasing the Margin of Safety of their aggregate position further.

True risk is a permanent loss of capital

A permanent loss of capital occurs when the cash paid for a security cannot be recovered, either because the security was bought at an inflated price compared to the real value of the underlying business, or because the underlying business has deteriorated. Earning back irrevocably lost capital takes time: for example, if a security bought for $100 is later sold for $60, it will take more than 6 years earning 8% a year on the remaining $60 to recover the lost capital.

A low market price is not the same as a loss of capital
Intrinsic Value investors, when confident in their estimation of the intrinsic value of an investment, are not concerned by a weak market price. Markets reflect differences of opinion and the currently prevaling one may not necessarily be realistic. Furthermore, opinions change. Intrinsic Value investors know it pays to be patient and tend to view lower market prices as buying opportunities. In this they differ markedly from investors focused on short term results, who, without the benefit of an intrinsic value reference, may too easily conclude that an investment is “unsuccessful” because of a weak current price.

In the end, low prices only matter if you have to sell when prices are low, or if you choose to be sensitive to short term price movements. Please see “For Short Term Needs” below.

Selling securities
Over time, security prices move between extremes of pessimism and optimism. Once a security has been bought (often at a time of pessimism for that security), Intrinsic Value investors believe that it is only a matter of time before its market price will rise toward its Intrinsic Value, at which time the security will be sold.

When fair pricing returns (market price close to or equal to Intrinsic Value), Intrinsic Value investors become highly disciplined sellers and recover their capital. The reason is that fully or overpriced securities have much more downside than upside, and the risk to the invested capital does not justify holding them. The more conservative option is to go back to cash and look for the next undervalued opportunity.

How long an investment cycle (from cash to investment to cash again) will last cannot be known in advance. Intrinsic Value investors need to maintain the right perspective until fair pricing can be obtained, knowing that the Margin of Safety captured at the time of purchase – the larger the better – will offer a measure of protection for their capital.

For short term needs
It is impossible to know in advance when the Intrinsic Value of any holding will be recognized, and market prices may decline at any time. Intrinsic Value investors should therefore set aside capital to manage their short term cash needs. Capital set aside to cover short term needs should be held in cash or cash-like guaranteed instruments to ensure its short term preservation.

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