· A brief look into the 10 principles used by fundamental value investors as detailed in Stephen Penman's book, Accounting For Value.
1. One does not buy a stock, one buys a business.
- This point reminds us that, when buying stocks, one buys not paper but claims on a business.
2. When buying a business, know the business.
- Successful business rides on a good entrepreneurial idea and the translation of that idea into value through business operations.
- Valuation, in turn, is a matter of translating one's knowledge of the business model and its execution into a price for the business.
3. Price is what you pay, Value is what you get.
- Price is what the market is asking the buyer to pay, value is what the share is worth. Fundamentalists entertain the notion that prices can "deviate from fundamentals."
4. Part of the risk in investing is the risk of paying too much.
- As a matter of first order, the risk is in buying a stock rather than holding it, and that risk is the risk of paying too much.
5. Ignore information at your peril.
- Start by asking yourself what information is relevant? And "How do I pull that information together?"
6. Understand what you know and don't mix what you know with speculation.
- Don't contaminate what you know - your reliable information - with conjecture.
- Focus on "value justified by the facts"
7. Anchor a valuation on what you know rather than on speculation.
- Particular weight should be given to what is known, to discipline speculation, to keep it in check. Accounting, based on "what we know" anchors a valuation.
- Calculation: Value = Anchoring accounting value + speculative value
8. Be aware of paying too much for growth.
- Fundamentalists are aware that growth is the most speculative part of any valuation, so they are disciplined about buying growth.
- We have another call on accounting: Account in a way that protects us from paying too much for growth.
9. When calculating value to challenge price, beware of using price in the calculation.
- If one seeks to challenge price, one must refer to information that is independent of price; price is not value, so do not refer to price in calculating value.
10. Return to Fundamentals: Prices gravitate to fundamentals (But that can take some time).
- Active fundamental investing rests on the notion that prices can deviate from fundamentals buy ultimately return to fundamental value.
- Earnings drive stock prices, so the fundamentalist focuses on "long-run earnings power" with the recognition that prices will adjust to earnings information as it arrives.
Penman, Stephen H. Accounting for value. New York: Columbia U Press, 2011. Print.