Value Investing: Questions & Answers

In my every training of value investing, I always give an opportunity to the participants to ask questions related to the material presented, either in the event or after the event (through email). Some questions required short answers, and some others require long answers. Here are some of them. Please check, you may have also had the same questions.

I only want to buy liquid stocks, in this case the stocks that enlisted in LQ45, or blue chip stocks. But why their prices are so high? It is so hard to find a blue chip stocks that the price reflected PER of less than 7 times, or PBV of less than 1.0 times. If I found one, the fundamental of the company is usually bad, so it is not worth to be bought as well. What should I do?

Actually the answer to this question lies in the question itself, ie when you say 'I only want to buy liquid stocks'. Now, if all investors have the same thought (only want to buy liquid stocks), and that’s the fact, then of course the price of liquid stocks will never be too low, is not it? Because there are always some guys who want to buy it.

That is why in value investing, liquidity is one of important elements in assessing the value of a stoc. Two stocks could have different valuations even if they have fundamentals/financial performance that are equal, if one stock is more liquid than the other, where the liquid stock is valued higher because investors are prefer to buy it than the illiquid one.

There are at least two reasons why investors, both retail and institutional, prefer liquid stocks. The first is because of the ease to buy or sell it. Liquid stocks are much easier to be sold or purchased at any time because there were always people who places bids and offers. The second is because the liquid shares are relatively safe from the ‘stock making’ practice, so the price could move in line with the company’s fundamentals or the market, so that the movement patterns can usually be analyzed using technical analysis. Different things happen to non-liquid stocks, where the price can be very fluctuative, influenced by the actions of certain large investors who sell or buy it. If you are accustomed to use technical analysis, you can see for yourself that the price charts of LQ45 stocks LQ45 are usually more 'smoother' than the charts of the penny stocks, are not it?

For large insitutuonal investor like Schroders, their stocks are none but ASII, BBRI, UNVR, etc

One more thing. Sometimes it is not the liquidity that caused a stock to be less valued (compared to other stocks with fundamentals that equal but more liquid), but: The stock price has been too low until the holders are no longer willing to sell it, usually because they hoping that the price could still go up again (if a stock is labeled 'no hope', then the price will continue to slide down until stuck at Rp50 per share), and on the other hand also no investor who place bid to buy it. Thus there are no transactions, and the stock becomes illiquid.

This condition often occurs in companies with good fundamentals in the past, but its current financial performance is poor so that its stock was down significantly to the level that is 'could not be more lower'. Stocks like this are usually moving sideways in a certain time period (and with thin liquidity), and eventually rise back if the relevant company's performance improved (which makes the investors to buy the shares). The stock of Elnusa (ELSA) may be a good example. ELSA had dropped to below Rp200 per share (from about Rp500 per share) due to loss suffered by the company, and stays at the price level for a number of months with a very small frequency of trading transactions, but the stock eventually rose (with sizable liquidity) after the company's successfully making profits.

Other than liquidity, a stock deserves to be valued higher if it represents a well-known company, or in my term, has big name. It's so simple: If you are asked to choose a Samsung mobile phone or another brand at the same specs and price, which one will you buy? Samsung, of course. And despite the fact that Samsung (or Apple) phones are valued higher than Huawei, Evercoss, Xiaomi, Advan, etc, but still they sold better. Well, the same thing also happened on the stock, which you will not be able to equalize the valuation of shares of Bank BCA (BBCA) with Bank ICB Bumiputera (BABP), for example, even if the two banks have an equivalent quality of financial performance.

However, this does not mean that you can value a famous and liquid stocks and with exorbitant valuations. If you consider that stock A can be bought at 1.5 times of PBV, where A is a non-liquid and the company was not well known, then stock B, which has more or less equivalent fundamentals to stock A but more liquid and the company was well-known, you may buy it at PBV 2.0 times. But if the price (of stock B) stood at the level of 2.5 times of PBV, then maybe you better hold your cash. In essence, after you gave 'tolerance' that the LQ45 and blue chip stocks are deserved higher price than most of the other stocks, but still none of them are fair enough to be bought, then wait a minute. Please check the position of Jakarta Composite Index (JCI), usually in bullish.

Sir, you once said that we can buy Astra International (ASII) at a price of Rp6,000 per share, or below. But yesterday when the stock was down, the decline stopped at 6,150 before it then rebound. How’s that?

One of the basic principles in value investing is, there is never an exact figure about how much the price of a stock, whether it ASII or other, can be said to be low/fair/overvalue. Fair price of a stock is nothing else but opinion, where two investors could give two different figures when asked about fair price of a stock. For example, although I assume that ASII’s price could be said to be low enough at 6,000 or below, but if there was a large number of other investors who think that ASII’s price under 6,500 is already low, and that's why they continue to buy it at the price range of 6,000 – 6,500, then of course the stock can not go lower than 6,000, can it?

In contrast, although I assume that ASII’ price is already low at 6,000, but if there are shareholders of ASII who take off their shares in large, then the stock can go down deeper, may be up to 5,500, 5,000, and so on. The point is, just because you (or I) assume that ASII already low in 6,000, it does not mean ASII can not go lower (or higher) than that.

The solution to overcome this issue is to buy the stock gradually. If we are using ASII case, then even though you think that the ideal price is below 6,000, but if ASII already traded at prices below 6,500 after a long stay at 7,000's, then you may buy it using small money first. In this way, if later ASII continue to fall to below 6,000, then you can continue to buy, this time in larger quantity. But if ASII quickly rebound instead of dropped to below 6,000, then you still gained some profit because you already own the shares. And the rest of your funds (because ASII did not dropped further) could be allocated to other stocks.

But what if ASII continues to fall down to 6,000, 5,500, or even 5,000? For example, if the market was down? Well, if it happens so, then at some point you will (eventually) run out of cash, and your portfolio position becomes stuck. But do not worry because in the end, as long as you buy the right stock at the right price, your stock will rise again. Last year I began buying BBRI gradually when it traded at below Rp7,500 per share, and buy more when the price already under 7,000. But in fact, in line with the weakening of JCI weakening, BBRI continued to slide down until touched 6,150 as its lowest point. As a result, our position became loss! But well, can see for yourself, what is the today’s price of BBRI? (although, I must admit, I already take it off to buy it later at the lower price).

May I ask for confirmation about how long are 'short-term', 'medium' and 'long-term'?

Some literature states that the short-term are 1 – 2 years, medium term 2 – 5 years, and long term is more than 10 years. However, because the performance of Indonesian stock market, including the development of the sectors in it, are very volatile, I chose to be more realistic. In my opinion, the short term is less than 3 months, medium-term is 3 months to 1 year, and long term is more than 1 year. There are some stocks in our portfolio that we have held for more than one year, but to be honest, the number are small compared to other stocks that we may sell/buy it back in less than a year. You know, every time we see that the market may be dropped, we may do the 'clearance', do not care if the prices of our stocks are still low.

And one of the misconceptions that need to be clarified here is that value investing is not about long-term investment or short-term trading, but a strategy to buy good stocks at lowest possible price. When you buy good stocks at bargain prices, then it just a matter of time before the stock price will go up until it can not be said to be low again. The 'time' here can be very short (you buy the stock in the morning, and it already skyrocketted in the afternoon), one or two weeks, a few months, to a few years. Most people remember only that 'a few years', so they thought that value investing is an investment strategy in the long-term. However, if you bought some blue chip stocks when the JCI was dropped in early 2014, hence, less than one year, you’d earn sizable gains, right? And you will always have the option to exit you position at any time, if the price of the shares you hold is no longer undervalue.

But of course, value investors tend to avoid excessive trading, like swing trading which applied by a trader who thinks that he was Michael Schumacher. We do trade, only with a little bit patience.

Do you applying the Discounted Cash Flow (DCF) or the Discounted Dividend Model (DDM) in calculating the value of a stock?

No. I do not even understand what DDM is (DCF, I do understand a bit). But as far as I know, Warren Buffett did not use the two techniques. If you read the Berkshire Hathaway annual letter (which written directly by Buffett himself), this old-buy-youthful man never mentioned the techniques of valuation outside of PBV, PER, and the dividend yield, plus one more, a technique to calculate the intrinsic value of shares as described herein. If you read books about Warren Buffett's investment strategy that are written by someone else (not Buffett himself), that’s when you will find the DCF, DDM, and possibly other valuation techniques. However, I assume that the author may deliberately add those techniques so that the book looks thick only.

Okay, I think that's all. I’ll see you next week.