Value Investing in a QE3 Economy

Since Ben Bernanke released his latest bond-buying program, also known as QE3, U.S. and European stock markets have tacked additional gains on to a summer rally built on anticipation of such a program. They weren't let down. Not yet, anyway.

As was the outcome of both prior rounds of easing, the overall market indices continued their ascent although each successive program has predictably shown a decreased positive impact on equity prices. With aggregate corporate earnings growth stemming primarily from cost-cutting, i.e. smaller workforces and declining spending, the effects of quantitative easing have primarily served to artificially inflate asset prices. Underlying demand for stocks, as demonstrated by market volume, has continued to decline.

Earnings growth, employment, and thus overall economic growth has been flat even amidst the purposeful devaluing of U.S. and Euro currencies. Now, proponents of Federal Reserve and European Central Bank stimulus programs will point to measured inflation (when food and gasoline are extracted from the rate) as justification a government can continually devalue its currency until economic growth returns. However, these proponents still can't point to any proven, concrete benefit that the first two rounds of programs have delivered. The only argument is "Imagine what it would be like if we hadn't done it."

Well, that's up for debate. And so far, aside from undue increases in gasoline and food prices (amidst declining world demand) the long-term effects are not yet known. However, we can deduce that easing programs have done nothing to spur organic economic growth; the kind of growth so important to an investor when making forward-thinking decisions.

So, as an investor in an environment where market prices are not primarily derived from supply and demand conditions, but from artificial demand provided by government bond purchases and thus a systematic debasing of the world's reserve currencies, how should my investment strategy encompass this new reality?

First, one must keep in mind that with each new round of quantitative easing, associated marginal returns have declined. So, simply buying an asset, whether a stock or commodity, and expecting a subsequent rise in price may have worked under the first program but is unlikely to continue to work as well. With this thought in mind, traditional asset pricing models, i.e. earnings growth rates, will continually become more relevant. As world economic growth rates slow, a prudent investor will only seek out undervalued assets; those with low P/E ratios relative to their peer groups and/or those with high yields. Many times, emerging markets can provide both growth and yield while remaining somewhat buffered from the volatility of the world's reserve economies.

Second, implement this value strategy with a long-term horizon, but reevaluate every six months. New opportunities, and risks, seem to arise much quicker in a volatile world economy than in traditional one. It is safe to say that as long as central banks continue to intervene in asset markets, the likelihood of a random precipitous decline or advance remains high. As a value investor, these events present valuable opportunities, and not being aware of one's positioning can quickly equate to missed opportunities or unnecessary losses.

Finally, put excess reserves and savings to work in a municipal bond fund to avoid taxes and grow your savings. It is more important than ever to have money on the sidelines, but as world currencies are debased, keeping up with inflation becomes more difficult, and thus parking reserves in U.S. dollars or Euros is eroding your returns. Savings accounts at local U.S. banks are yielding approximately 1/10th to 1/5th of one percent. This is costing you money, not just in missed returns, but in decreased spending power. There are many states if in which you reside and purchase your state's local and/or state bonds, returns are exempt from local, state, and federal taxes. Take advantage of it.

I base my time horizons on six month periods, and continually reevaluate my holdings while planning for the next six months. Many times, I hold my investments for much longer than six months, and many times for a shorter period. In this economic climate, blindly buying and holding leads to "the lost decade" or what many have dubbed the first decade of the 21st century. Returns on investment only become lost when we don't adapt to continually changing economic realities. Everyone who is still sitting back on their heels waiting for "a return to normal" will still be waiting in another ten years. This is the new normal.

Article Source: http://EzineArticles.com/expert/Michael_Lasko/1253046

A Beginners Guide: Value Investing

One of the greatest investors of all time, Warren Buffett, has proven that value investing can work: his value strategy took the stock of Berkshire Hathaway from $12 a share in 1967 to an astonishing $70,900 in 2002. Although Mr. Buffett does not hold himself only to value investing, most of his investments were made on the basis of value investing principles.

A value investor looks for stocks with strong fundamentals or strong earnings, dividends, growth, and cash flow. The basic principal of value investors is that you should first find out what the true price of a share of stock is and then determine if it is undervalued. After you have determined its stock price is below what it should be you would then buy and hold it until it gets back in equilibrium. There are several ways to find out exactly how much a certain stock is worth. The most basic way to do this is determining the company's book value. Book value is calculated by subtracting total liabilities from total assets. If a company has a history that you can go back and check to see what it's average market value to book value ratio this method would prove to be a key factor in your valuation. We can't stop with just book value though we must dive deeper.

The next major indicator I would look at is price to earnings ratio. The P/E ratio determines how the market feels relative to the earnings that the company is making. You would want to look at the stocks historical P/E ratio and determine where their current P/E ratio relative to historical. If it is below the historical average, we could say that the stock is undervalued.

A lot of the time when I'm picking a stock with this method I will also look at the major stock holders and try to determine if any hedge funds or other big institutions have picked up this stock recently. If they have then I will just move on to another stock because it has already been discovered.

Here is a breakdown of some of the numbers value investors use as rough guides for picking stocks. Keep in mind that these are guidelines, not hard-and-fast rules:

• Share price should be no more than two-thirds of intrinsic worth.

• Look at companies with P/E ratios at the lowest 10% of all equity securities.

• PEG should be less than one.

• Stock price should be no more than tangible book value.

• There should be no more debt than equity (i.e. D/E ratio < 1).

• Current assets should be two times current liabilities.

• Earnings growth should be at least 7% per year compounded over the last 10 years.

Remember these are rough guides. You can always try out some new stuff and see how it works for you. Value investing may not seem as sexy as some other styles of trading or investing but it relies on a strict screening process that helps you get to know the company you are buying in order to make the best decision.

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Article Source: http://EzineArticles.com/expert/Jarrod_Barber/1021150

Value Investing the Warren Buffett Way

There are almost as many definitions for the term, "Value Investing," as there are people using it. No wonder it can be confusing. However the quintessential definition belongs to the way Warren Buffett does it.

After all, he's made over $50 Billion doing it his way. So if you're going down the Value Investing road, you may as well follow the man who is most successful.

Now most people think that Value Investing is simply buying cheap stocks. Unfortunately there are some serious downsides to simply finding cheap stocks, even fundamentally solid ones, and buying them.

First, the market could take a very long time to realize these stocks are undervalued. At the end of the day, it doesn't matter whether you own excellent value if nobody is willing to pay you for that value. This is called the realization-of-value-problem and is a very real concern, for anyone who invests money in the stock market, because the longer it takes the market to realize the true value of a company, the lower the compounded annual returns will be.

To see why, let's look at an example where a stock that has an intrinsic value of $10 a share is selling at a discounted $5 per share. If the market realizes the stock's true value in a year, the annualized return will be 100%. If it takes two years, the return will be 41.42%. Three years? 25.99%. Five years will return 14.87% and ten years will give a 7.18% return.

As you can see, the differences in annualized returns are significant, and we really don't know when the market will fully value the shares.

Another problem is that a company might look attractive at a particular point in time, but a host of intangibles, such as management integrity or government regulation, that weren't reflected in the numbers could cause an excellent business to decline in the future.

To guard against this occurrence, Benjamin Graham, Warren Buffett's mentor, would widely diversify, sometimes holding hundreds of stocks in his portfolio. He expected some would not perform well, but believed that the ones that did perform would more than offset the ones that didn't. And he was usually right, as his results often showed.

However Buffett soon tired of this way of thinking and started searching for a more efficient way to invest. He famously said that, "wide diversification is only required when investors do not understand what they are doing." This was not a slight at his mentor Graham, who would have agreed with Buffett, because Graham himself had to admit that he did not understand all of the companies he held. There were just too many of them.

Buffett eventually found what he was looking for in the works of John Maynard Keynes, Lawrence Bloomberg and Philip Fisher. When he combined their philosophies with Graham's, he arrived at an investment strategy that has served him well over the past five decades.

Buffett used Keynes' concept of the concentrated portfolio to focus his investment analysis on areas that he knew very well, and no others. During the Internet technology boom of the late 90s, Buffett refused to participate and was ridiculed by many for missing out on huge profits. However Buffett had the last laugh when the crash inevitably came. To this day Buffett does not invest in technology firms because he says that he doesn't understand their business models.

Bloomberg contributed the idea of the consumer monopoly (or economic moat). This is a business that has an extraordinarily high barrier to entry. It could be because of lucrative patents (think pharmaceutical companies), brand (for example, Coke) or a real monopoly (such as Microsoft Windows).

Bloomberg determined that such companies should be able to grow their earnings faster, which would lead to higher returns on equity and, eventually, higher share prices. By filtering on this criterion, Buffett was able to eliminate a large number of companies that had higher risks of failing. This one idea allowed Buffett to remove the need to diversify as widely as Graham had because he was relatively certain that the companies he chose had a far greater chance of success.

Coupled with Keynes' notion of intimately understanding a company's business model, Buffett was at last able to do away with Graham's need to diversify over hundreds of stocks.

Fisher's contribution was the idea of investing only in top-notch businesses and never selling them. This contrasted starkly with Graham's strategy of buying undervalued businesses and then selling them when they reached fair value.

Putting it all together, Buffett now had the seed of his investing strategy. Look for fundamentally solid stocks that represent good value with a built-in margin of safety, invest only in top companies that have a high barrier to entry, only invest in what you know, concentrate your holdings and hold your investments for a very long time.

If you'd like to outperform the stock market, then you can do very well following Buffett's method. He's already proved it works, so why not put it to work for you?

A professional software developer, Mark Hing has over 20 years of investing experience. For the past 10 years he's been creating powerful, easy-to-use investment software packages based on the enduring principles of Value Investing stalwarts such as Warren Buffett and Benjamin Graham.

Mark's best-selling software package is the acclaimed Value Stock Selector. It was designed for investors of all levels to help them find undervalued stocks sporting exceptional fundamentals with just a few mouse clicks.

To learn more about Value Investing and how you can automatically find the best Value Stocks, go to http://www.ValueStockSelector.com

Article Source: http://EzineArticles.com/expert/Mark_Hing/517764