10 Commandments of Value Investing

Once in a while we (investors) need to be reminded of the concrete rules that have been proven successful by famous investors to make money in the market. The following are the 10 concrete rules for value investing.

Low Price-to-Earnings (P/E) Multiples: Search out stocks trading at less than 10 times price-to-earnings multiples, which reduces the risk of overpaying for a security.

Low Price-to-Cash-Flow Multiples: Look for companies trading at less than five times a price-to-cash-flow multiple. This also reduces the risk of overpaying and uncovers many dirt-cheap equities.

Discount to Book/Net Asset Value: Buy stocks trading at a discount to book/net asset value. In many cases, this not only uncovers significantly undervalued stocks but also prime takeover candidates.

Hidden Assets: Some examples of hidden assets that can be uncovered after a thorough analysis are tax-loss carry forwards, over-funded pension funds, real estate, potential spin-offs, IPOs and favorable litigation.

Management: Two types of management could be key in the search for a turnaround candidate: a) solid, proactive management and b) poor management, which leaves the company ripe for a proactive acquisition or merger.

Products/Services in Tune with 2008 and Beyond: This includes expandable, growing markets with good margins. We tend to avoid companies with outdated, shrinking products.

Value Catalyst: To push up the value of a stock, we look for a significant value creator. Some examples of possible value creators are fresh management with new directions, an important sale or purchase of a meaningful asset, an unsolicited takeover bid or disgruntled and impatient proactive shareholders who may put pressure on management to make changes or sell.

Discounted Valuations Compared with its Peers: Comparative valuation measures such as price to earnings and cash flow could indicate a takeover by relatively expensive Canadian or foreign competitors looking to expand market presence.

Contrary Opinion and Under-followed by Investment Analysts: With little investor exposure, undervalued stocks are pregnant with possibilities, providing very little buying competition when we attempt to accumulate the security. Generally, an undervalued and under-followed security will offer terrific capital-gains opportunities.

Discipline: Stay on track and adhere to strict value discipline of low P/Es and strong cash flows and price targets. Do not get sucked into buying the flavor of the day! Combine patience and persistence to attain superior performance. Patience! Patience! Patience!


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