Sketch notes on Geoff Gannon’s article "How to Know a Stock Is Cheap Enough to Buy".
He quotes Richard Beddard:
- Whether management has made good decisions in the past
- will the company products be in demand for years to come
- financially strong
- judging if it is undervalued,bearing in mind the preceding factors
Geoff concurs with that analysis. He illustrates its application thus:
If you believe most decent businesses are worth at least 12 times earnings, you don’t have to drive yourself crazy trying to figure out whether Company A which is superior to Company B is a better buy at 11 times earnings than Company B is at 7 times earnings. If you love Company A, buy it. You will do fine over time if you can buy your favorite businesses at 11 times earnings. This is not an approach that will backfire. And it is an approach you can apply year after year after year.
Applied to net-net investing:
So if your entire investment process consists of nothing more or less than ranking every stock below NCAV from best to worst – the company you’d be most comfortable investing in for the next ten years to the company you wouldn’t hold for a nanosecond – that’s a fine approach. That will work.
So don’t overweight cheapness. Contrariwise:
I’m not saying this because the cheapest net-nets are the worst. They aren’t. I actually have some data to support the idea they may be the best if you stick with the system of buying the cheapest net-nets and holding them through some really tough times. The problem with that approach is that it is based on huge winners offsetting rather frequent losers. And frequent losses are very hard for investors to overlook. So, I’m afraid it’s not a strategy anyone would stick to. High quality net-nets offer a lot more solace even if they don’t result in quite as jaw dropping returns as buying the riskiest net-nets.
Net-nets succeed and net-nets fail. But they rarely liquidate.
A 5% ROE stock is not something you want retaining your earnings and growing the business. It’s something you want to flip – the sooner the better.
Where there is just cash and no decent business I feel differently. I don’t like those stocks.
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