“Price is what you pay. Value is what you get."
Price doesn’t necessarily reflect true value, which is why we only strive to target the most valuable investment opportunities at the lowest prices. As 3D Value Investors we want to know the fair value of a business; what it is actually worth, rather than what the market tells us it’s worth. The key question we seek to answer is: What price should the shares really be?
Valuation is the second dimension of 3D Value Investing. In our previous blog, Fundamental Analysis: Giving You More Value For Less Money, we focused on the importance of fundamental analysis and why combining all three of the dimensions, fundamental analysis, valuation and timing are so vital to investing success. By following our valuation process we are able to determine the fair value of businesses and ultimately find value in the multitude of global investment opportunities.
The following is an excerpt from our eBook, 3D Value Investing: Triangulating The Best Investment Targets.
3D Value Investing’s Valuation Process
For 3D VI intrinsic value, or true book value, is only one of the factors we analyse in order to reveal the fair overall value of a business.
By combining future growth forecasting, cash per share, terminal value and net present value for example, 3D Value Investors are able to see a far more rounded view of business value. This is why we call it fair value.
The down side of using only the intrinsic value of a business to determine whether its current share price is accurate, is that it does not take into account the trajectory that the business is likely to take. While we are interested in the snapshot of where a business currently stands, we also need to get a good idea of where it is heading.
Determining the Consider Buy and Consider Sell prices
We want to know how much we should pay to buy into a business and how much we should sell our shares for in order to make the best possible return. Calculating fair value allows us to pinpoint two very important prices in this process: the consider buy and the consider sell.
Once the fair value of the business has been established, we can then blend in the other factors already determined; strength, returns, dividend, earnings predictability and depth of economic moat.
Finally, this stage of analysis closes the loop in our calculations of the margin of safety, by revealing to us the percentage by which a share is under or over valued.
Fundamental Undervaluation and Forecasting Growth
A forecast for shrinkage or negative growth can still mean growth in the share price. A business might be so fundamentally undervalued today that it would have to shrink for several years before its value reaches its current market price. Such a business is a victim of extreme market over-reaction – and presents a great opportunity for a 3D VI.
Future growth forecasting is notoriously tricky and nobody can claim accuracy here. The difference for 3D VIs is in the standpoint from which we look forward. Once again, in order to understand and estimate what we don’t yet know, we look back at all the things we know for sure.
Our refined process of fundamental analysis is once again key here. Yes, it allows us to identify shares for sale at prices far below what we calculate they should be worth, but so does traditional fundamental analysis. Using our 3D VI techniques, we are able to go much further.
By looking at the path we believe a business is going to take and how well it is run we can calculate the prices at which we would buy into, and later sell out of, our investments. Once we have these target prices, we know it is only a matter of waiting until the time is right for action.
Many investors are put off an opportunity if the business in question appears to be shrinking rather than growing. But shrinkage does not automatically mean the value of the business is in decline. Sometimes a business must reinvent in order to grow so a diminished profit margin does not necessarily accurately reflect negative growth. In fact, this increased reinvestment rate is often a precursor to stunning positive growth, especially if the investment is made by a motivated and talented management team.
As most analysts are primarily focused on quarterly financial announcements, businesses are regularly given inaccurate growth forecasts based solely on a three-month view. This quarterly snapshot really is a very blinkered outlook when compared with the panorama presented by 3D VI fundamental analysis, growth forecasting and valuation together.
Think Like a Computer: Switch Off Emotion
Gut instinct, personal opinion and market fashions have no place in the selection of 3D VI opportunities. We have to remove our emotional response to the branding, what they sell or where they are based and look instead at cold, hard facts.
Branding and marketing gives businesses an identity, a flavour, a face and a character. It clarifies the target market, is designed to make the business appealing to potential customers and can prove extremely detrimental to investors.
We are genetically programmed to formulate opinions about what we see and corporate branding taps into that primal sway. Marketers want to generate an emotional response in all of us, hoping to grab our attention; ideally instilling proprietary loyalty, the branding Holy Grail.
In order to make sound decisions, we must ignore everything the branders have spent so much time and energy devising to turn our heads. We must also recognise that a strong aversion to a company’s branding is just as dangerous as a strong attraction.
A business isn’t valuable because you love it, have always been loyal to it, or your dad swore by it. On the flip side, a TV ad might make you want to tear out your eyes, yet look past this and the company behind it might represent a great investment opportunity.
It’s not just branding that turns us towards or away from a company. Our opinions of their products or services, industry sector, or a personal like or dislike of the management style / team; it could be any mixture of elements. With 3D VI, it doesn’t matter if you have no clue about a particular sector - you don’t need to know.
Our experience has taught us if we adhere to our investment principles and analyse opportunities using the three dimensions, we achieve great results. 3D VI translates into consistent, long-term returns regardless of market, geography or currency.
Our next blog in the 3D Value Investing blog series will cover the third and final dimension, timing. We will show you how we use it to target the best times to buy and sell. If you can't wait, you can always download our free eBook with more in-depth coverage on the matter.
Want to learn more about 3D Value Investing and the benefits it holds? If yes, click "Download Now" on the image below to download a complimentary copy of our eBook.
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