Book Review – The Little Book of Value Investing by Chris Browne

For those of you who have read some of my previous comments on investing, you know that I have a “fun money” fund which I use to invest in individual stocks. You also know that, for the most part, I haven’t been able to keep up with my simple Index fund investments in my IRAs and 401Ks. Imagine that, a stock picker who doesn’t do as well as the Index, who would have thought?

However, the purpose of this “fun money” is for me to learn about investing, stock picking, and what works (and what doesn’t). To do this, I’ve taken to doing some reading, looking at articles on the net, and planning my future purchases.  In that area, I took the opportunity to review the Little Book of Value Investing by Chris Browne. The book seeks to go through the concepts for value investing in a short amount of text, but still provide sufficient “value.”

The book starts off with a couple of chapters going over the basics of value investing, basically discussing the concept of “intrinsic value” for a stock (what it is truly worth, without hype or negative news). It provides some basic history of the concept, based on Benjamin Graham’s initial work, and the author displays his “credentials” with it, due to his father’s company being the firm that did most of Graham’s trading (they were located in the same building).

The book then dives into the various places to seek value stocks (large cap, small cap, international, etc.) The author discusses his early work with his father’s firm, where he searched through documents the old fashion way, before the advent of computers. This enabled them to find good bargains, because there weren’t many firms willing to do the deep research necessary to find the bargains. For example, back in the day, the firm was able to find a large number of companies selling for less than the cash the company had available!

Today, with modern computers and data, it isn’t as easy to find bargains like that, but it also is easier to get a list of companies with some of the criteria for value, and then do additional research to find the one you want. The book’s final chapters go through the process of how to do that:

  1. Create list of Candidate stocks
    • Price to book value below 2/3
    • Price to earnings
    • Price to net current assets
    • Buying of shares by insiders
    • Visit competitors data
  1. Determine why are they cheap
    • Too much debt?
    • Didn’t make earnings estimate?
    • Cyclical?
    • Competition?
    • Obsolescence?
  1. Review the Balance Sheet (especially trend over last 5-10 years)
    • Current assets 2X current liabilities
    • Long term assets vs. liabilities – is ratio increasing over time?
    • Debt-to-equity ratio: less than 1 (or company being funded by debt) – compare with other companies in the industry
  1. Review the income statement (again looking at trends
    • Revenue growth
    • Expense growth in line or less than revenue growth?
    • Gross profit percentage (revenue – expenses / revenue). Is it growing?
    • Earnings per share, and diluted earnings per share (which take into account stock options). Trend?
    • Look at trends over last 5-10 years. Here is where you are going to find how the company is doing
    • Return on capital ratio & trend (should be rising)
    • Net profit margin & trend (should be rising)
  1. Research other factors of company (products & their outlook, Can it be as profitable as it used to be, One time expense that affected price, unprofitable operations that can be shed, competitors, etc.)

Finally, the book goes into one of the key parts of value investing – the fact that it is a Marathon, not a sprint. To invest for value means you are going to purchase a stock that is worth more than it is currently selling for – and then wait for the market to realize that fact. It may take a month, a year, or several years. To be a value investor is to be  a patient investor. If you don’t have the patience, then maybe this strategy is not for you.

 

Of course, that is something that I’m struggling with.

 

Mr. 39 Months

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