(Image Credit, gurufocus.com)
Value investor, Arnold Van Den Berg founded Century Management in 1974. He is a principal of the firm, the Chief Executive Officer, and co-Chief Investment Officer. According to investment-advisors.credio.com, Century Management has $1.03 Billion in Assets Under Management.
Van Den Berg has no formal college education but gained his market knowledge through rigorous self-study, tremendous dedication, and over 45 years of industry experience.
Back in 2013 Van Den Berg did a fantastic interview in which he provided a simplistic model on how he selects his investments. It’s a great read for value investors.
Lets check it out…
This excerpt is taken from the 2013 interview by Manager Review with Arnold Van Den Berg. You can read the full interview here, Manager Review Interview, Arnold Van Den Berg.
Q. Why do you believe that value investing is a better way to manage money?
AVDB: Value investing does not appeal to the masses. If it did, you would never be able to buy a bargain. Stocks selling below their intrinsic value or below what an experienced businessman knows his company is worth, bargain stocks, are usually only found during times of great uncertainty.
Because of the fear surrounding uncertainty, many people are willing to sell stocks well below their intrinsic values and often times at bargain-basement prices. Typically this happens because a company, an industry, or in some cases the market at-large has a problem, which is usually temporary. Regardless, history has proven that investors who buy these bargains will frequently be rewarded when the uncertainty clears.
This is as fundamental as it gets, and you can use this approach for any investment, whether it’s stocks, bonds, real estate, commodities, or a private business. As Benjamin Graham said, “Price determines return.” And, as his famous disciple, Warren Buffett, stated, “Uncertainty is the friend of the long-term investor”.
Q. What is your approach to value investing?
AVDB: Jim Brilliant, our co-chief investment officer, explains it best when he states that the main focus of our investment philosophy is to recognize and capitalize on value gaps. Simply put, the value gap is the difference between the price of a stock and the underlying value of the business.
Benjamin Graham once said, “In the short run, the market is a voting machine, but in the long run it’s a weighing machine.” That’s exactly what he was describing. He was describing how in the short run, market gyrations move stocks all over the place, but the underlying value of the business is what defines the price over the long run.
As an example, let’s take a cyclical company with a strong balance sheet. These are some of our favorites. We know at the bottom of the cycle, it generally loses or doesn’t make much money, at the top of the cycle it’s making a lot of money, and in between it is growing its earnings appropriately.
On Chart 1 (below), I have isolated the tangible book value per share for our sample company, which is one of our favorite 14 valuation metrics that we use to value businesses. Tangible book value, for those not familiar with it, consists of all the assets of a company minus all the liabilities, which gives you the net worth or book value of the company. From there, you subtract the value of goodwill, patents, and copyrights, and what you have left is tangible book.
Looking at Chart 1, you can see that while there have been ups and downs along the way over the past 20 years, the tangible book of our sample company has grown rather steadily over time. Now it’s cyclical, so there are some ups and downs. But, over 20 years, through all the economic ups and downs, the tangible book has grown pretty nicely over time.
Now let’s look at the stock price during this same period on Chart 2. It’s volatile. It has gone from $5 to $25, back to $5, up to $10, down to $5, back up to $30, back down to $8, and so on.
The value investor sees this volatility and says, “What a great opportunity.” However, the masses generally say, “This stock is way too risky, I’ll pass.” We are full believers in the “buy low, sell high” investment philosophy, so to us this would be a great opportunity. Now it’s time to apply our value gap methodology, and on Chart 3 we put Charts 1 & 2 together to compare price and value.
What you notice on Chart 3 is that every time the price hits tangible book, it’s the bottom of the stock price.
Furthermore, it doesn’t stay down there very long. This also coincides with the time that the stock is the cheapest and where the reward-to-risk is the greatest. Unfortunately, it’s also the time when the masses typically become fearful of the volatility, often times selling these stocks or ignoring them altogether, and thus give up the potential for a great opportunity.
Now that we know the stock typically hits bottom when it’s selling at tangible book, the final step is to convert this into a price-to-tangible book ratio in order to see what this ratio has been at any time over the past 20 years. On the side of Chart 4, we show numbers zero through eight.
The number one represents 1 times book, the number two represents 2 times book, and so on. The Value Zone shown on the chart suggests it is a good buying opportunity when the stock trades at 1 to 1.5 times tangible book value. Conversely, any time the stock sells at 3 to 4 times tangible book, we would suggest the stock is in the Expensive Zone and selling is in order.
When we wrap everything up, we put it into our valuation structure. In this example, we would set our worst case at 0.90 times tangible book, our buy point at 1.15 times tangible book, and our sell point at 3 times tangible book. While we use many valuation metrics to arrive at our total valuation, as certain valuation metrics are more relevant to certain companies and industries than others, we believe this process in valuing a business allows us the opportunity to capture the value gap and make the volatility work in our favor.
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