Modern Value Investing by Sven Carlin

Sven Carlin is a YouTuber and investor who performs research on the stock market and has made several interesting counterintuitive investment offers. He’s also written a book about investing in the stock market, the details of which I have captured here. I’ve never read a book by a YouTuber before and this was my first one.

-The single greatest edge an investor can have is a long-term orientation; Seth Klarman

-It is not possible to make rational investment decisions if your current lifestyle depends on your investments

-Compound interest is the 8th wonder of the world. He who knows it earns it, he who doesn’t, pays it. Einstein

-Investing in the long run is a positive sum game as earnings increase

-Be unemotional about investments; the difference between intrinsic value and price, capture the advantage during discrepancy

-Buy a company when it is going down, in intervals (stop buying if it goes back up) to give one a liquidity cushion when buying a stock

-Always keep cash on hand 10-40% of the portfolio at any given time

-Speculators usually buy high as they need a buying signal from a previous upward market move

-Value investors buy at market bottoms from pessimists, sell at the top to optimists

-Patient investors can buy low and sell high

Chapter 2

-Modern portfolio theory taught in school is complete lies. Low risk, low return, high risk high return is not true.

-ETFs lead to less liquidity; stocks in ETFs will be subject to higher volatility and less on fundamentals. Stock market declines therefore stocks in ETFs will be greater

-Best the market by buying small caps under $2 billion

-Avoid declining sectors with declining fundamentals as the book value undergoes massive impairment write-downs

-Value investing is out of favor in the mainstream

-Focus on absolute returns, not relative returns

-Recessions crush most investors except value investors

-focus on minimizing risk and then maximizing return

-Analyze every detail of the business

-black swan: an unexpected financial occurrence that has a massive effect, Nassim Taleb in “fooled by randomness”

-Hedge risk: all-weather portfolio, hedging (difficult), margin of safety (easiest)

-barbell strategy; most of our money is in low-risk strategies, and 10-15% is in high risk. But, none for medium-risk

-Potential black swan: hyperinflation from loose monetary policy

-It is in human nature to forget bad experiences in favor of good ones

-Invest in stocks with asymmetric risk; low downside and high upside. Investing in the S&P 500 right now would have a negative expected value as there is a 50% downside but maybe only a 20% upside

-Small stocks have the most inefficiency and most reward as least covered. However, even 15 minutes a day on large caps can yield large returns (e.g. Facebook December 2018)

Chapter 4

-crucial to be an optimist when investing, that the stock market will do well over time

-Evolution wires people to think in an all-or-nothing manner rather than probability-wise

-People behave in cycles like the market and become overly pessimistic at the lowest point and sell and get out, only to buy in at highs again

-theory of reflexivity by George Soros; people are biased thinkers who can cause self-fulfilling prophecies. So, bad spells and good spells may last longer in stocks. Thus, hold longer or wait to buy. Business fundamentals may be affected or cause it

-fallibility; We try to simply complex things in the world to try to understand, even if we don’t

-reflexivity in investing; when a trend changes directions, or shows signs of it, that is the time to buy or sell. This can make lots of money on short-term bets, such as buying and selling IPOs. Buy before a bubble, sell before twilight (the bubble popping)

-Buybacks help if below intrinsic value

Back of Napkin valuation is often worth more than hundreds of spreadsheets of data

-bet the farm when you have a bargain as it doesn’t happen too often

In addition to intrinsic value, four additional value calculations:

-net present value (NPV), liquidation value, stock market value, and the value to the private owner

-#2 NPV; PV of future cash flows-stock price. Or, more accurate is net income PV as it is most correlated to actual value. For riskier businesses, like mining, go as high as 20% in discount rate. For less risky, like blue chips or S&P 500, do 10-year treasury yield plus a premium, say between 1-10%.

PV=FV/(1+I)^t

NPV=summation of PV FCF- stock price

-Perpetual earnings growth formula (PV=current cashflow/(I-g)) not recommended due to recessions and uncertainty

-Emerging markets; 10 years. Blue chip; 20 years and a lower discount rate, justifying a longer period

#3- liquidation value

Net tangible assets-liabilities

If positive (below tangible book value), then in theory cannot suffer a loss. Drawbacks: Many companies’ assets are overvalued and worthless in a fire sale. Just like avoiding companies with lots of debt, avoid large pension liabilities

-Liquidation value is worst case scenario value; discount assets by 30-50% more for write-downs

-The value of assets however may not match numbers on a balance sheet; in real life, they could be worth far more.

-#4; stock market price if holding company

-#5; acquisition value; wait for acquisition target. Difficult, more acquisitions happen in the later stages of the economic bull cycle. Intrinsic value is the most important measure – book value and change in book value is the most important measure.

-#6; measuring intrinsic value; value of past investments (conservative book value with discounted assets), earnings growth, value of future earnings

-#7; ROIC is the most important metric over the long term. There is a cost to holding cash, so a business with a strong ROIC track record and is fairly priced or has a slight discount and has a strong moat is worth buying.

-Companies that invest in the long term via expensive capital expenditures that see a return in years get discounted much heavier; those companies, like Gazprom and potentially Disney, are buys. ROIC=net income/capital (equity plus long-term debt and short-term debt)

-#8; Growth is a key component of value. Growth is inherent in value investing; those who say it is different are ignorant. Look at gross margins and operating margins (higher is better).

#9; CAPE ratio (cyclically adjusted price-earnings ratio). Average P/E for the last ten years. Start calculating this one manually if I have to by taking an average of P/E’s. But buy when it is low.

-2018 CAPE ratios; Russia 5.6, US 31.55.

-Earnings growth with low CAPE is what to buy

-Holding cash with a margin of safety has an opportunity cost

-#10; cash per share, and more conservative, net cash per share

-cash and cash equivalents (easily turned into cash) – total debt

-Beware: Companies that don’t make money, will burn cash

#11; sustainable dividend. Based on margins, ability in a recession, net profit, cash flow

-The numbers matter the most, but a qualitative margin of safety is key too, as most cheap stocks are cheap for a reason. Some competitive advantages: new technology, legal, IP, market share, brand, pricing power, etc. Industries with a slow rate of change have competitive moats. Industries with a fast rate of change will only have a moat for a limited amount of time.

#12: Some moats: low-cost provider, high switching cost (Microsoft), network effect (Facebook, Amazon), brand (Apple), reputation (Google, band-aid, Kleenex), economies of scale (initial high cost, low future competition (utilities, delivery), government protection. It is far more difficult to find a moat in today’s world. Therefore, the holding periods and future trajectories must be shorter.

#13- google. Use Google to find companies reputation, negative articles, and risks, buy its product and see it from a consumer side vs. a numbers side, how it treats its employees, corporate governance, management, and integrity. Googling a company provides great high-level insights.

-#14; good management. Look for a company where the management has full ownership authority. For E.g. Facebook with its super common shares is good because Zuckerberg can make decisions, as opposed to hedge funds inconsistently running the show

-#15; Acquisition targets provide a margin of safety

-#16; it all boils down to the price you pay. If want a 15% return, then a price-earnings ratio of 6.6 would be a bargain (assuming good growth rates). Earnings yield (inverse of P/E ratio). A business can be undervalued even if it is at all-time highs.

#17; cyclicality of a sector; Invest when the sector is at a low, for example, natural gas as the gas prices are at a decade low. Thus there is more upside potential and less downside. Best scenario: stable supply, slow supply, or declining supply with increased demand. If supply increases more than demand (oil), that is not a good sign.

#18; position in the economic cycle. Recessions are usually only 11-14 months, so don’t wait too long. Also, avoid value traps as value investors.

#19; Look for future catalysts that will induce rise. If there is none, then the stock will stay low below intrinsic value forever, even if illogical. Potential catalysts: from conference calls, sector trends; specific market developments, future events, or finished production of long-term capital expenditures.

#20; avoid sectors in long-term decline. E.g. oil with generations of supply, especially if overly competitive

#21; Look at insider activity; for non-option exercises, massive insider selling from everyone is a bad sign

#22; sustainability of dividend; if not sustainable, price drops. However, Peter Lynch would buy stocks after they got to the bottom in terms of dividends

#23; market sentiment. A company, sector, or country can be in the negative for a long period. Sberbank, Russia’s largest company, had a P/E of 4 in 2015. In 2017 it 5x in stock price.

#24; quality of assets on the balance sheet. Canadian oil companies, with their low P/B ratio, occur because the assets are worthless and are heavily overstated. Therefore, a classic value trap.

Chapter 9 – how to find bargains

-Traditional value investing only by the numbers is not actually that hard; that is why, particularly for large caps, they are rarely 50% below intrinsic value. Therefore, value investors must go into the unknown: spinoffs, acquisition potential, liquidations, risk arbitrage, emerging markets, businesses in the sin bin, future dividend growth, buybacks, revenue growth, and new ventures.

-Complex securities with investments in other companies such as SoftBank may be undervalued due to valuation pitfalls on other stock investments

-Accounting complexities such as Apache Corp making up an adjusted lower net loss (23 billion to 130 million in 2015) accounting lies or misstatements: goodwill, too much inventory or AR, tax, impairments, unfunded or pension liabilities.

-Risk arbitrage: between 2 similar companies, the one more likely to be acquired, at similar valuations, is better.

-IPOs; One can buy good IPOs and buyouts for bad IPOs (wait for the lockup period to expire if to buy)

-Small caps can also be a great option; under 2.5b, and possibly below book value; with good growth. They offer higher returns, less coverage, and less liquidity (everyone wants to confirm by owning famous stocks)

-higher debt and higher production cost companies are not value investing

-Hyperbolic discounting; people will take the short-term reward over the long term, even if the long-term reward is way more. Thus, companies with longer-term investments, buy into those investments before Wall Street funds start massive positions.

Top-down investing is what most people do – they look at the trend and invest in the trend, regardless of where valuations are

Bottom-up, trickle-up approach; a first look at underlying fundamentals, margin of safety, book value, P/E ratio, and earnings growth.

-When a company doesn’t have the earnings growth expected by the market but is still growing at a good pace, then that is a good time to buy.

-Don’t take financial risks in life, should be low-risk high-reward investments for the most part. Don’t overcomplicate, as financial setbacks are typically life-altering for the negative.

-Warren Buffett and Seth Klarman: It’s crazy to use stop losses and not at all a risk-limiting tool. If a good stock price falls, you should be buying more, not selling.

-Gold has risen about 6 times in the last 15 years; close to the FEDs balance sheet increase

-Fixed long-term loans are good hedges against inflation

-currency risk hedge by diversifying internationally

-Consider hedge options when they are very cheap (in heightened bull markets)

Chapter 13 – Avoid Value Traps

-Avoid structural weaknesses (retail) and go for temporarily distressed companies

-When price moves fast, people tend to move into fight or flight mode and make impulse buy or sell decisions. Avoid price anchoring

-Go in-depth into a stock or sector. The youngest analysts are usually in the less attractive stocks

-Recalculate intrinsic value as it changes based on genuine negative news

-Learn how to say no to avoid money-losing stocks or negative situations

-accounting scandals, resignations, dividend cuts, after waiting a long while, after will be time to bet the farm

Disclaimer

This is not Financial Advice. This article is meant only for educational and perhaps entertainment purposes.

You may also like:

Want to keep up with our blog?

Stay up to date on new blog posts