Finding Value

“Just like hot potato, you better not be holding the stock when the music stops playing.”

My wife is learning about investing and she asked me a very poignant question, “how do I know if I should invest in a company?”  I feel like this is a question on the minds of many new comers to investing. 

The reason for this is that, no one will tell you that there are actually 2 parts to learning to invest.  First is learning what investing is and then comes the application of the knowledge.  The latter is often the most difficult part.  Anyone can read a book and learn, but how do you apply this knowledge. 

So getting back to my wife’s question, “How do I know if I should invest in a company?”  The simple answer to this is Value.  Most Human beings are intelligent individuals and can spot a good value when they see one.  How many times have you said, “that’s a good deal” or “you got robbed”.  Think for a moment about the last time you uttered these phrases and what caused you to come to that conclusion.  In order to know if something is a good deal or not, one has to compile facts, compare to something similar, understand market demand and reflect back on what you have experienced.  This is everyday human psychology.  We utilize this process, whether we’re buying vegetables or a used car. 

Think about what it takes for you to put a price on something or come to terms with a price of something.  Valuation of a stock is no different.  Try to wrap your head around this concept.  A stock priced at $100 is not simply reflecting a price.  Built into this price are several factors and those factors together make up a price.  The simple answer would be it’s a $100 because there are more $100 bids than ask, i.e. demand near $100 is strong.   However we are not looking for a simple answer.  I want you to learn how to put value on a company and know what price is the right price.

If I told you that I want to buy a used car and my budget is $10,000.  Think about the questions you would ask me.  The thing about buying a used car at $10,000 is that you could by a Benz or a Hyundai.  You can buy a really old Benz, or a newer Benz with a lot of miles.  You could buy a newer Hyundai with fewer miles.  There are a few factors that go into the value of a used car.  The price reflects these factors.  If I said I bought a Benz you would be curious and ask, new or used?  I’d say used.  So you would ask me what year.  I’d say 1995.  You would ask how many miles on it, and I’d say 200,000 miles.  At this moment you’re zeroing in on the price before we get any further.  What’s happening here is that you are taking the following factors and working them into the price:  Benz, Used car, 1995 model year, 200k miles.  You know that the price is going to be low before I even told you the price I paid.  This is the same process you can use to select a stock to invest in.

Simple example, which company should you invest in at this moment, Coke (KO – $54.93, Div $.44/ Yield 3.20%) or PepsiCo (PEP – $65.15, Div $.48/ Yield 2.95%).  What questions should you ask yourself before you invest in either of these companies?  If Coke and PepsiCo were actual people, and you had to lend money to them, what would you want to know about them?  Here is a list of questions I’d ask:

  • Revenue – How much money they make
  • Profits – How much money they keep
  • Growth – will they be opening up new markets
  • Debt
  • What other business’ do they own besides soda
  • Future plans
  • What events have caused significant drops in price
  • In a 5 year horizon what will the stock return

 I get the question about what to invest in all the time.  My response to this is a question, what is your strategy.  We will discuss strategy in another article but for now learn the companies and sectors and if you want to learn, start at a high level, select a sector.  Health care, pharma, real estate, consumer goods, etc….  learn about it and try to find a good value in those sectors. 

So now you know about Valuation.  Simply defined valuation is a set of factors that add up to a price, a price that reflects demand.  This is a tricky concept and may not come to you right away.  You can always ask me, I won’t charge you, yet. 


Pragnesh Drew Patel, is an ardent believer in the notion that, the opposite of poverty is not wealth, but justice.  Poverty and the monetary disenfranchisement of a large swath of humanity is not the result, but a design of our modern capital system and it’s only through education and financial literacy that we can have true equality.  For over a decade, Pragnesh Drew Patel has been committed to teaching and mentoring those who are interested in building real wealth, through informed investing.  His investment philosophy is inspired by Value Investors, like Benjamin Graham and Warren Buffett, but his investment approach is an Art of War playbook, crafted around the 2 number 1 rules of investing, Don’t Lose Money and Never Settle for Mediocre Returns.  

 

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