The earnings season for the first quarter of this year has just begun, so it is worth considering whether company reports can form the basis for investor decision-making and analysing some of the methods of the best-known investors.
What to look out for before investing?
There are a number of elements to look out for before making investment decisions to try to avoid unnecessary investment mistakes. The first is that the financial performance of a company does not always translate into an increase in its shares. The share price depends more on expectations about the future. Another important element is the approach to long-term investment. Investing based on Warren Buffett's strategy of investing in companies with a long-term advantage requires an approach that does not focus only on short-term financial performance. Buying shares only because of positive results seems a mistake also because attention should be paid to the nature of the business. Good investment practices includeavoiding investments in sectors that someone does not fully understand, as this is an additional risk in the form of misinterpreting market conditions.
Why is Buffett investing for long-term value?
Warren Buffett is an investing legend and one of the most well-known figures in the financial world. His investment style is well defined and widely known as 'value investing'.
Buffett seeks to invest in companies that have solid business foundations, stable earnings growth and a strong market position. He often chooses companies in an industry that he knows very well and finds easy to understand.
A key feature of Buffett's investment style is long-term thinking and patience. The investor prefers to hold on to his investments for the long term (the average holding period per share is as long as 17 years). We have learned from a number of interviews and letters to shareholders that Buffett believes that patience and perseverance are key to long-term investment success.
Buffett is also known for his excellent price sense and his investment strategy focuses on buying undervalued companies. The investor seeks to buy companies at a price that is lower than their actual value, which provides him with high profit potential in the future.
In summary, Warren Buffett's investment style is to invest in companies with solid business foundations and strong market positions, to hold investments for the long term, to be patient and to focus on the value of the investment rather than short-term share price movements.
It seems that a significant proportion of investors in Buffett's Berkshire Hathaway fund do not realise that the company was also one of his biggest investment failures. The story of the billionaire's purchase of Berkshire Hathaway began in 1962, when Buffett noticed that the company was undervalued. Berkshire Hathaway was a textile manufacturer at the time, and Buffett recognised that its value was far greater than the share price on the market.
Accordingly, he began buying Berkshire Hathaway shares, but increasing cheaper competition from China meant that the company began to run into problems. Buffett, accepting his mistake, said he had an opportunity to turn it into a better managed and more diversified holding company.
Over the following years, Buffett continued to invest in various industries through Berkshire, including Coca-Cola, as well as buying other holding companies such as GEICO and General Re. With his ability to find successful companies and a long-term strategy, Buffett was able to increase the value of Berkshire Hathaway from $19 per Series A share in 1965 to almost $500,000 per share today.
The story of Warren Buffett's purchase of Berkshire Hathaway seems a good example of how what is currently cheap does not always turn out to be a good investment. This may have developed the billionaire's investment style to invest in companies with very good brand names and potential for long-term growth at reasonable prices.
Source: Conotoxia MT5. BerkshireHa, Daily
Peter Lynch, or investing in growth at a reasonable price
Peter Lynch had a different approach to investing than Buffett. The former Fidelity Magellan fund manager ran the fund for more than 13 years, with assets growing from $20m to $13bn between 1977 and 1990. His investment style could be described as Growth at a Reasonable Price (GARP), which means investing in companies that are not yet giants in their industry and have growth potential but are still attractively priced.
Lynch focuses on researching companies and their businesses, and his approach to investing is based on the philosophy that investors should bet on companies that they know (or even are customers of) and understand well. The investor looks for companies that have strong business fundamentals, stable earnings growth and a competitive edge in the market.
Lynch is known for using his experience as a consumer to spot companies that may have high growth potential. It also looks for companies that offer unique products or services that differentiate them in the market.
Lynch believes that an investment should be treated like a business and therefore carefully analyses companies' financial statements to understand their valuations. Unlike many investors who focus solely on share prices, Lynch examines companies' business fundamentals, such as price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, price-to-book (P/B) ratio, as well as revenue and earnings growth rates.
In summary, Peter Lynch's investment style is to invest in companies with growth potential that are still attractively priced, to focus on researching companies and their businesses, to use his experience as a consumer to spot companies with high growth potential, and to carefully analyse companies' financial statements.
Aswath Damodaran and business valuation
Aswath Damodaran is an internationally respected corporate valuation specialist and professor of finance at New York University. His investment style could be described as 'value investing' using company valuation tools, but a more accurate term would be to say that his style is investing when you know the value. It turns out that value investing can take many forms.
Damodaran believes that a key feature of investment success is the ability to identify undervalued companies. The investor focuses on examining the business fundamentals of companies, such as their financial stability, growth prospects, competitive advantage and their position in the market. To do so, he uses a number of company valuation tools, such as cash flow analysis (DCF), as well as valuation models based on the ratio between enterprise value and EBITDA (earnings from operations) using the EV/EBITDA ratio, among others. The investor is known for his thorough research of individual companies and industries, as well as his ability to determine their value, which he shares on his YouTube channel.
Damodaran believes that investment in companies should be treated like a business, and it seems particularly important to accurately determine value. An investor seeks to invest in companies that have foreseeable growth potential and a low valuation.
In summary, Aswath Damodaran's investment style is to invest when you know the value using company valuation tools. The investor focuses on researching the business fundamentals of companies and their value, and uses a variety of valuation tools. Damodaran focuses on investing in companies that have a low valuation to their intrinsic value and are able to generate high returns with this
Piotroski F-Score - one of the fastest tools to determine a company's fundamentals
If we do not have the time or advanced knowledge of fundamental analysis, the Piotroski F-Score may come in handy, especially before deciding to invest in a company. This is a fundamental analysis tool used by investors to assess potential investments in companies. This method, estimated by Professor Joseph Piotroski of Stanford University, is based on the analysis of 9 different financial ratios that have been selected to determine the financial health of a given company. These ratios include return on assets, return on equity, cash flow ratio, earnings growth rate or debt, among others.
For each of the nine indicators, the Piotroski F-Score awards one point depending on the company's performance in the indicator. For example, if a company achieves an increase in profits compared to the previous year, it would receive a point, but if profits decrease, it would not receive a point. In this way: the higher the F-Score, the better the financial health of the company.
A study by Quant Investing showed that, on average, companies with high Piotroski F-Score values (8-9 is considered high) had long-term returns that were around 23 per cent better than the broad market. Companies with the lowest values (0-1) had, on average, worse returns by as much as 13 per cent relative to the S&P 500 index (US500). This may be due to the fact that such companies may have liquidity problems in the long term and would be forced to increase debt on unfavourable terms.
Grzegorz Dróżdż, CAI, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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