DAMODARAN: Five Cautionary Notes For Every Value Investor

aswath damodaran

Photo: YouTube

Value investors buy stocks that they consider to be trading at less than intrinsic value.  Warren Buffett is a well-known value investor.However, it can be very unpleasant being a value investor.

Value stocks don’t always recover their perceived value in a timely manner.  In fact, more often than not, prices will sink further. And the investor inevitably questions whether he made a mistake.  After all, it’s always possible that the stock will never recover its value.

In a recent blog post, legendary NYU finance professor Aswath Damodaran said that he believes there is now a 90 per cent chance Apple is undervalued.  He described himself as a “value optimist” on the stock.

But he doesn’t expect the stock to just go straight up from here.

For those courageous value investors who are have have decided to “take the leap” on Apple, Damodaran offers five cautionary notes.  These notes apply for all value investors.

'No matter how confident you are in your value assessment, don't go overboard and invest a disproportionate amount of your portfolio in Apple. This is not just about you being right on the value but also about the market coming around to your point of view, and that is not in your control or mine; betting more than 10% of your portfolio on this stock strikes me as foolhardy.'

Source: Musing on Markets

'I have never been a fan of dollar averaging, which not only muddies the water about when/how much you invested in a stock but results in increasing your bets as the market goes against you. Take a stand against the market but do not make this an ego trip, where admitting that you are wrong becomes impossible to do. Thus, while I feel more confident now that the stock is under valued than I was a week ago when I bought the stock for $500, I don't plan to buy more shares.'

Source: Musing on Markets

'The old adage that you are buying a piece of a company, not a share of stock, is particularly relevant when you make a bet like this one. My intrinsic valuation is determined by Apple's capacity to generate profits and cash flows and is not dependent upon whether portfolio managers are investing with me or analysts are lowering their price estimates. If I buy Apple at $440 today and I can hold the stock, I will get a share of a cash that is paid out and a share of ownership in the cash that is withheld. I have to keep reminding myself of that truth, even if the market moves against me.'

Source: Musing on Markets

'In an increasingly connected world, I know that this is really difficult to do, but there is no harm trying. Turn off your financial news channel, don't read opinion stories about Apple and avoid equity research reports like the plague.'

Source: Musing on Markets

'The big question that those of us who chose to make this bet face is what the catalyst will be that brings the market back to its senses (at least as we see it...). From my experience, it is almost impossible to tell. For instance, how did Netflix, which was a tailspin, a year ago, turn itself around? There was no single precipitating event but a collection of small news stories and solid earnings reports that seemed to settle the fears that investors had about the company's future direction. With Apple, it could be a new product, a couple of healthy earnings reports or a stock buyback. '

Source: Musing on Markets

Now, sleep well

'Let me close by saying that I will go to bed tonight, not thinking about what Apple's stock price will do tomorrow or the day after. I have made my choice and I am at peace with it. If you lie awake at night thinking about the stocks you have bought or sold, you just failed the final test of value investing.'

Source: Musing on Markets

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