This is a reworked article that I posted back when Chroma first started, but no one read it, so it is new information to anyone hanging out now.

What is this Value Investing Blog about anyway?

Since you are at my blog, I will summarize to you what I think is important. This is not a complete list. These ideas are not listed in any particular order. You didn’t go to Gray investing. This is Chroma Investing. Hopefully I can bring a little color to what everyone else seems to think is black and white. There are hundreds of blogs about investing and many have not just different but contradictory ideas. Which is correct?

Figuring out what  is right and what is a load of crap takes time. If you don’t  understand the basics of investing, you will have to learn them. Hopefully that is part of why you are here. And that you like sarcasm. That is a bonus. If I am tired I often leave it out.

Investing Advice from a non Professional

1) Take it slow.  You didn’t learn to drive in a day. You won’t learn how to invest in a week. There will still be good deals whenever you are ready. Don’t invest with real dough until you have worked through the fundamental investing ideas enough so that you know how you want to invest. That means if someone says they have a great tip, that you better get in now, before the market closes in fifteen minutes. Pass. Run away. They may be right. But you won’t be able to figure it out that fast. Unless have already done research on that particular company. And you believe them. And they are right. That’s a lot of “ifs.”

2) as Graham said, you need to make sure you are protecting your capital before you are earning on it. O.k. that is a paraphrase.  And not a very good one, but the idea is right. There are a million ways to lose your money. Don’t jump off the bridge, unless the bungy cord is properly connected. Make sure you are not taking unnecessary risks or being rewarded too low for the risks you are taking.

3) Get out of debt. This is an easy one. Unless you are the next Warren Buffett you will not be making more money from investing that you are paying on credit card debt. Unless you have been able to secure some incredible deal on a loan, you will be burning cash until you get out of debt. That said, even the master Buffett has used leverage ( a fancy word for borrowing) on occasion. If you know what you are doing, leverage is not a bad thing. Used sparingly and fully understanding the risks. Even many of the financial professionals seem to misunderstand the risks involved with leverage. Just ask Nassim Nicholas Taleb the master of explaining risk and probability and how stupid we really are in understanding it. Taleb is at least a week of posts given the importance of his work in understanding down side risk. (Taleb has two great books that are must reads for humans and doubly so for investors. They are The Black Swan  and Fooled by Randomness).

Investing Well Means, Investing Differently

4)  Have fun. Seriously. If you are not having fun investing for yourself, you will probably cut corners on your research, or fail to update your spreadsheet or valuation tools. Or fail to grasp the fundamental principle that investing is a zero sum game. If you wine somebody else lost. If you aren’t having fun, drink good wine instead. Some people are beer drinkers, not investors, enjoy the brew instead.

5)  Be comfortable with the fact that you will never, ever have perfect information about anything you invest in. I am not kidding. This is one of those facts that most people missed in the course of college, or grad school, or kindergarten, whenever they got the best info in their life. You will need to embrace the unknown. If you understand the Macro side of economics, you will miss the Micro side. Many professionals will have a problem with this point. Ignore them, this isn’t their blog.

6) Don’t be afraid to keep your money in cash. If you don’t know what to do, or no good deal presents itself to you- Do nothing. Remember Benjamin Graham- preservation of capital first. Be Patient and be confident in your choices. Then change with new information.

7) There are always deals to be had. Sometimes they are good, sometimes they are great. Sometimes they suck donkey. Go for the great ones. If you can’t find anything that looks great to you see point Six again.

8)Don’t be afraid of annual reports. Annual Reports are like Security Analysis , everyone says they read them, but few people do. Apart from the numbers most of the good stuff is the gems that tell you to run the other way. Good info and sometimes they put right there for everyone see.

What Makes You Different as an Investor?

9)Develop an investing strategy. Listen to everyone you can read. I will expose you to a bunch of great sites and books and investors. Take it all in. Then figure out what makes sense to you. If it doesn’t make sense you dump it. It doesn’t matter if your neighbor Tom has made a killing in Apple stock. If you don’t understand how he did, or if you understand but, it doesn’ add up some how, then find another strategy. Your goal is not to be like other investors but be better. Your goal is to make money.

10) Know what your edge is. Warren Buffett has said stay in your circle of competence. To me this means that we all have special knowledge and talents. Get some self knowledge and decide how that gives you an edge. Low volume penny stocks for example can be an edge for small time investors over mutual funds. IF you can’t stand all the detail pick an investing style that doesn’t involve combing through boring reports.

11)  if your investment has a looming catalytic event or person, or group. Pat yourself on the back.  I like catalysts like liquidation. It helps develop a time frame for your stock investment. But don’t count on it.

12) Make sure you have an Roth IRA. Remember if you do well in investing you want to keep your profits. I love the USA, I just don’t want them taking all my hard earned investment profits.

Buffett is a Genius but you Can’t be Like Him

13) Buy and Hold forever isn’t an investment strategy. Buy and hold is a great strategy for Berkshire Hathaway, the corp that Buffett runs. They are huge and you can’t move ships that big, very quickly. But the nimble small time investor needs to be clear when an investment is good to buy and when it is good to sell. Buffett didn’t follow his own advice when he was younger and had hedge fund like partnerships. See tip ten again. What is good for Buffett now is not necessarily a good deal for a beginning investor.

14) Don’t deworseify your investments. Peter Lynch coined the term. Stick to your good ideas. No small time investor should own 40 stocks. You don’t have time to track that many companies actively. Time is of the essence.

15) Do not dollar cost average. This is an idea so patently stupid it must have come from the same geniuses who gave us the Effecient Market Theory. Why would anyone invest in anything when it is clearly overvalued? Bet big when the deal is good, stay out when the deal is bad.

16) Research companies in advance. Have a watchlist of companies you might be interested in buying at the right price. Have a buy in price. If the price drops unexpectedly, you will be ready like a vulture to swoop in for the kill.

Be a Contrarian Investor

17) Falsify First. Don’t sprint into trying to prove your latest, greatest theory is correct. Try to disprove it. Take a shotgun to it and try to fill it with holes. Karl Popper would be happy.

18) Don’t follow the herd. Really. There are a lot of stupid people investing. They are not stupid because they lack intelligence, but because they lack the courage to be different and discover for themselves what is a good investment strategy and a dumb one.

19) Consider some form of mechanical investing. I know this takes some of the ego out of the investing process. But really, would you rather have a fat investment account or take credit for the intelligence of all your investing ideas. (Yes they are often mutally exclusive) Wait, most of you are answering the wrong way.  The right answer is get out of the way of your investing decisions and make money.

O.k. so maybe that wasn’t 20 things about value investing, but it is close enough. I think I said everything I needed to say with this blog. I guess I can retire.

Disclaimers: If you go to Amazon and buy a book I am hocking, I get a tiny, very tiny commission. You will have my gratitude and you can feel good knowing that you have supported a worthy cause: this site. I am not a professional investment advisor, you shouldn’t follow anything I say or even what professional investment advisor says without checking it out yourself. This is the internet. Its mostly all crap.

Related Posts:

• What is your Investing Edge?
• Why You may Want to Invest for Yourself
• 3 Must haves for your Value Investing Notebook
• Mutual Funds – Beginning Value Investor Terms
• Greenblatt, Ackman & Value Investing Masters speak at the Value Investing Congress

What?

If you compare an asset, say stock in a company, to a market, say the S&P 500, you can establish a relationship between them. For example a beta of zero means that the stock will move independently of the market. A beta of one means they are perfectly correlated.

Beta is also mistakenly used as a description of risk. As Ben Graham said, “Beta is a more or less useful measure of past price fluctuations of common stocks. What bothers me is that authorities now equate the beta idea with the concept of risk. Price variability yes; risk no. Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earnings power through economic changes or deterioration in management.”

Amen, brother. Sometimes it is better to let Ben Graham speak and get out the way.

Another thing to remember, in a crisis all assets have a beta of one.

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What is Low Price to FCF?

Two of the most important words in evaluating a company are Cash Flow. Old School Value Investors focused on Earnings. That is so 1950’s. I am not going to go into the details of Free Cash Flow. Please see the Chroma Investing Value Investing Terms FCF for a fuller explanation than I give here. The short version is that Free Cash Flow is what a company really has left over at the end of the year. It is the amount that you can turnover to investors in dividends, buy back stock, pay down debt or just let sit on your balance sheet.

Low Price to Free Cash Flow (P/FCF) is a measure that value investors find useful to analyze companies finances in relation to it’s current stock price. It is a stricter measure than the price-to- operational cash flow ratio as it backs out capital expenditures.  Here is the simple equation:

                                    Price to FCF = Market Cap / Free Cash Flow

A high ratio indicates that a company is expensive relative to its Free Cash flow. A low ratio shows that it is cheap in relationship to FCF. Like most of these value investing metrics you can reverse these and you will get the Free Cash Flow yield which is expressed as a percentage. With a Free Cash Flow yield, higher is better.

Simply put, Free cash flow is a measure of a company’s ability to generate cash, which is a starting point for stock pricing. Or as Warren Buffett said, “Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”

An easy formula for free cash flow is, FCF = Operating Cash Flow – Capital Expenditures. The numbers needed for the calculation are found on the Cash Flow Statement of the Financial Reports that a company issues in its 10K or 10Q.

How to use P/FCF in an Investment?

Let’s say you agree that using FCF can help you make your value investing decisions,  how might you go about it? Here are a few suggestions.

1. You can buy stocks in companies that are low in Price to FCF as compared to the market as a whole. That is you can compare the P/FCF of a company to that of the overall market. For example you could compare the FCF ratio of General Electric to the S & P 500. Although, I could not find this information on Standard and Poor’s own website.

2. You can compare Free Cash Flows to some arbitrary number, say 10 or 15. You may want to do this if you can come up with some historic norm for Free Cash Flow.  If you can review historical data of FCF over a long period of time, it is possible to come up with a normalized ratio. You could use that number as your comparison.  Again, this will be difficult since historic data for Free Cash Flow is difficult to obtain very far back.

3. You can buy a stock using P/FCF either as a solo investing criteria(not recommended) or in combinations with other factors. For example you might use FCF ratio with such metrics as low price to book, a high acid test ratio, high ROIC, etc.

4. You can buy a stock when a company has a Low P/FCF in relationship to its own 5, 7 or 10 year financial history. I always like to compare current ratios to historic ones to get a relative idea if this metric is cheap for this particular company.

5. You can buy the stock of a company who Price to Free Cash flow is low relative to its industry. In other words you take a look at Exxon’s FCF ratio and compare it to the oil industry as a whole to get a relative industry ratio.

6. You can buy a fund that specializes in Low Price to FCF. This may be an index mutual fund or an ETF. I don’t know of any pure play funds on Low P/FCF, since most value funds use a combination of factors, but perhaps there is one that has escaped my notice.

So, why is low price to free cash flow so important, that it is worth investing?

Importance of Low Price to FCF

Low P/FCF has been a good indicator in the past of what makes a successful investment moving forward. Let me give a few examples.

Peter George Psaras wrote a study called “Back-test showing the power of Price to Free Cash Flow in the Investment Process” where he back tested buying Low Price to Free Cash Flow stocks from the Dow Jones Industrial Average for 1950 to 2007. His criteria was simple: buy every stock that had a Price to FCF ratio less than 15 and sell it after a year. The results were remarkable. The performance was 22.77% on average over the 58 years. The average gain for the DJIA was only 7.82% for the same period.  Quite an outperformance

I asked myself the question, what does this mean right now? So I created a stock screen with Stock Investor Pro using data from last Friday August 5^th. Here are the companies passing the screen:

I am not recommending any of these companies, but it does give you some idea why some high profile value investors are interested in Microsoft, Pfizer and Cisco to name a few. Perhaps a few of these companies are worth some further research.

Other investing studies have used the less stringent  Low Price to Cash Flow ratio (P/CF). Let’s see if there was a similar outperformance.

Does Low Price to Cash Flow work in shorter time Frames?

In their study, “Contrarian Investment, Extrapolation and Risk, Josef Lakonishok, Robert W. Vishny and Andrei Shleifer reviewed all the companies on the AMEX and NYSE from 1968 to 1990. They divided up the companies in to ten selections called deciles by Price to Cash Flow. They formed portfolios that they kept for five years. What they discovered is that the lowest Price to Cash Flow stocks outperformed the highest  Price to cash flow stocks on average during a holding period of 5 years. The average return for the  low P/CF stocks was 20.1% per year and amongst the high P/CF stocks it was only 9.1% with cumulative 5 year return of 149.4% to 54.3%. Perhaps not as exceptional as the Psaras study, but significant none the less.

This is one of those studies that is useful only in the abstract. Realistically an investor is not going buy the lowest  10% of p/cf companies on any exchange.  But it does continue to show that when you are considering value investing metrics that P/FCF should remain in the toolkit.

Low Price to Cash Flow Internationally

All this may be well and good in the United States, but do these kind of value investing metrics work abroad? A Michael Keppler looked at this in his study “Further Evidence on the Predictability of International Equity Returns: The Importance of Cash Flow in Country Selection.” While he did not use FCF specifically, it is instructive. He found that from 1970 to 1989 in the eighteen countries studied that the lowest price to cash flow country indexes produced a result of 19.2% on average in local currencies compared to the highest Price to cash flow country indexes with a return of only 4.7 % in local currencies.

Since this was based on buying index funds this study has an actionable element. But it would require a little research. You don’t think I am spoon feeding you everything, do you? An investor could research index funds based on different countries stock markets. They would need to have P/CF information on each index (preferably FCF). Compare the indexes and pick a small basked of low cost to cash flow indexes.

If anyone does this research please report back.

Why does Price to FCF work as a Value Investing Metric?

No one knows for sure but here are a couple of my guesses.

1. Companies with low prices related to any value metric, Earnings, Book Value, Sales etc. are unpopular. Otherwise their price wouldn’t be low. Something is bothering the market, bothering it so much that it MAY be undervalued. Low Price to FCF investments are a contrarian investment by definition, and mostly people want to say they own Apple or Netflix, not Aeropostal or Microsoft.

2. Cash Flow may be more honest than earnings, a commonly used measure of a companies performance. As Damodaran said in his book Investment Fables, “Accountants measure earnings by subtracting accounting expenses from revenues. To the extent that some of these expenses are non-cash expenses … and because accrual accounting …does not always yield the same results as cash accounting, accounting earnings can be very different from cash flows.” (Italics are mine)

Having a healthy Free Cash Flow gives a company options. It is a sign of a financially sound company thriving in its industry. Free cash flow is often used for stock buy backs, dividend payments and in reducing debt.

Finding such companies is usually easier in a bear market ( like now) or when a company misses earnings, makes a mistake which leads to bad press, all of which can temporarily depresses its stock price. Investors finding such opportunities should, as they say, “strike while the iron is hot”.

Please come back each week as we write about various Value Investing Criteria to help you build your Value Investing arsenal. Add your comments if you have any thoughts about using  Low Price to FCF in investing. Finally, if you haven’t already done so, please sign up for email list (I promise I won’t spam you.) or like ChromaInvesting on Facebook.

Disclosures: I do not have any financial interest with aaii.com or Stock Investor Pro, but I am a paid member of the first and I have purchased the second for the past two years. I am making no recommendations on stock purchases or sales, just expressing my opinion on what I am exploring right now. I am not a professional investment advisor but a Film and television producer, thus everything here is for entertainment purposes only.

If you would like to download post you can here.

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ETF Defined

An Exchange Traded Fund (ETF) is similar to a mutual fund, but has similarities to purchasing stocks. The SEC says that ETF’s are “investment companies that are legally classified as open-end companies or Unit investment Trusts (UITs).” An open-ended investment company is one of the three primary groups of companies as described by the SEC. Unlike a close-end investment company, an open-end investment company can offer to buy back its shares from the investors.

A normal mutual fund is a pooled investment where the money from thousands of investors are joined together and invested in whatever the focus of a mutual fund is, such as equities, bonds or commodities. Conversely, a common stock is traded on a stock exchange. An exchange traded fund tracks a stock index, a commodity or pool of stocks, but is also traded on a stock exchange like a stock; the price variations occurring as people buy and sell the fund over the day.

 ETF – Good Value Investing Tool

ETF’s are very popular with value investors since they often have tax advantaged status. That is you don’t pay on the capital gains with the ETF only when you sell your investment. In the current law if you sell after one year that means long term capital gains which as of this writing is only 15%. Another reason ETF’s should be popular amongst the value investing crowd is that unlike mutual funds Exchange Traded Funds can trade at the same price as a stock Trade. Both TradeKing and Zecco charge $4.95 for an ETF trade the same as an individual stock.

ETF the Nitty Gritty

An ETF often represents a set of stocks. For example the SPDR 500, the oldest ETF follows the Standard & Poor’s 500 Index, which is an index of the 500 largest companies in the US. ETF’s portfolio would not change over the course of their lifetime and that means that investors are aware what they are investing into. If an ETF says that it is investing in energy stocks, then it is investing in energy stocks.

An ETF’s price is determined by their daily trade volume which is not the case with other funds. Because of the inherent benefits of Exchange Traded Fund, they are widely used as a preferred mode of trading across the globe with more than a few hundred Billion dollars having been invested in various funds across hundreds of indices.

ETFs do not sell individual shares to investors like Mutual Funds., large blocks of shares known as creation units are issued. The creation units are not purchased by the investors in cash, rather they are purchased in the form of a portfolio of shares which would represent the portfolio of the ETF. Investors after purchasing the creation units can either sell the shares in the secondary market or sell them back to the Exchange traded fund.

Another difference between a Mutual Fund and an ETF is that Mutual Funds have their Net Asset Values computed at the end of a trading day based upon the values of their holdings; they constantly trade in the market to reflect a better price. However Exchange Traded Fund gets their prices determined by the push and pull of the market since they follow a fixed basket of stocks.

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The mechanics of investing in a mutual can be simple. Say you decide on particular mutual fund, you sign onto your online brokerage account and purchase. Oh wait. This is where the not so simple part comes. There a couple of type of Mutual Funds. The first and most important is what is called a No-load Mutual Fund. Load stands for Load of crap or commissions. A No-Load Mutual Fund doesn’t charge commissions. There is no advantage to loaded Mutual Funds (pun intended). The take can be as high 5% or in the case of a level load fund, be an ongoing tax on your returns. There is no advantage to paying the commission in terms of investment returns, since mutual funds with loads don’t outperform no load funds as a group over time.

Mutual funds are like stock investments in that  they are not guaranteed to hold their value by any governmental agency like the FDIC does for bank accounts.

I use the word sheep earlier to describe investors in mutual funds. That is not quite fair. Warren Buffett has famously said that for an investor who does not have the time understand equities investments a good index fund is a good place to invest your money. The problem is that the majority of index funds under-perform the market over time. Even when a mutual fund out performs the general market, most individual investors still do worse than the market as a whole. They tend to buy right after a manager has had a great year or two and sell when the manager has had a bad year or two. In other words they buy at the top and sell at the bottom. In general, you can expect to under-perform the market by the amount of fees and expenses the mutual fund charges. This varies. Zecco, one of the discount online brokers I use, charges $10 for a no-load mutual fund purchased on line. TradeKing charges $9.95, this compares to $4.95 for a stock trade.

And don’t forget the tax ramifications. If you buy an active fund, every time they sell for a gain (assuming the holding period is less than a year) the fund will pass along the capital gains to you. This takes away the control of when you want to have capital gains or losses. This may be fine with you. It isn’t for me. If you are interested in someone else managing your money.

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Peter Schiff, one of the co-authors, is at least, by the evidence of this book and his podcasts, an attention seeking, ego maniac. The first surprising thing for me was,  there is actually some thoughtful information contained in the book. The second surprise is that I am writing this review at all. I mean, it is hard to get through listening to how great and prescient Mr. Schiff was about the recent financial crisis. I mean, I really, really wanted to hate everything about this book, because the author is constantly praising himself, hyping his brokerage company or services.  He is also not above political theater, spreading libertarian politics and unsupported ideas.

But when I read a book about the potential coming crisis he discusses, it peaked my interest in what I call worse case scenario investing. When looking at worse case scenario’s in an investing context,  I look for ideas that are persuasive. I am not really interested if everything they write is true, just that part of that writing forces me to reconsider my biases that may hinder me from making informed investment decisions. I am hoping that the difference in their views will help reveal my blind spots. So, while I am unconvinced on Mr Schiff’s ideas on gold, his other points should be considered.

Mr. Schiff asserts that the recent financial crisis is not the “big” one, but a prelude to a much bigger crisis to come. After breaking this imminent crisis down into possible scenarios, of inflation, stagflation or hyper inflation, which are all, I think realistic scenarios, he turns to solutions. His investment advice breaks down to three items. Buy foreign dividend paying stocks in foreign currencies, hold sufficient cash, and buy gold.

His ideas on Gold are polemic and narrow. His analysis of gold’s “intrinsic” value is is at best unsubstantiated. From a traditional Graham value perspective Gold has no intrinsic value. Klarman has also spoken about this. This has not stopped some value oriented hedge fund managers like David Einhorn from loading up on gold. Schiff’s initial assumption is that gold is “real money” and has “intrinsic value”. This is a value investing blog, so I will not spend too much time on debating gold’s merits. While in times of crisis Gold may, be able to preserve wealth in comparison to various currencies, it’s long term historic return has not been great. To use an Austrian falsification argument against the intrinsic value assetion one need only go to the Spanish conquest of the new world when the influx in gold was ultimately responsible for rampent inflation and a sovereign debt crisis in Spain. So much for intrinsic value.

I found his arguments on the potential economic crisis in the US and for the dollar, rather compelling. It is perhaps his Austrian school arguments that persuade me. To Schiff we have not yet seen the real crisis. Just a preamble. In Schiff’s theory the United States has an unsustainable economic future because we don’t “produce” anything any more. That most of our manufacturing jobs have fled to low cost centers around the world. While I am not quite convinced that manufacturing is the only “true” source of wealth creation. Our current national course of unsustainable debts, Quantitative Easing, anemic economic growth prospects and high unemployment make the prospects of the United States and thus the dollar dim in the long term.

The notion of buying foreign stocks, denominated in foreign currencies, is his most interesting idea. I frankly, had not considered it before reading Crash Proof 2.0.  It would in essence allow an investor not to be trapped in a low growth environment of the United States. It is somewhat difficult to implement for several reasons. First, identifying currencies to have your investments in, may be as difficult a task as picking the market peaks and valleys. Because ultimately all currency trades are pair trades and in this case that another currency will appreciate against the dollar. What currencies would that be? Not the yen or Euro. And then screening and finding companies in the chosen currency, is well beyond the scope of small or beginning investors. Most online brokerage companies don’t allow much international investing, and finding screeners and other international investing information sites is really tough. But, every time I have a spare moment, I keep looking down this road. It is an intriguing path and should be considered. If I find more. I will send up the signal flares.

I usually have high cash holdings, because unless everything is a screaming deal, it is better to have some cash on hand to take advantage of an opportunistic investment, so I don’t need to be convinced of this.

In the end check out a copy of the Crash Proof 2.0 from the library. It is worth perusing, but may not be worth an investment.

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It is a term that Benjamin Graham and David Dodd coined in their seminal book, Security Analysis. First Graham began with the idea of intrinsic value. Or how much a company is worth (in opposition to how much it costs). If the price of a companies’ share  is lower than the intrinsic value of that share then the difference is a margin of safety. Graham argued for a minimum margin of safety of 33%. More is better, but harder to find. The purpose is to protect an investor in case some part of your analysis in determining the intrinsic value is incorrect, or  to help protect if the market or luck turns against you.

In a recent example VOXX, my NCAV value was $9.82/share. By my reckoning this would be VOXX’s intrinsic value. The price when I bought VOXX was $6.60/share. This gave me a Margin of Safety of about right under 33%. Any questions? Please post in the comments or email me chroma@chromainvesting.com

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What is the risk free rate? It is the rate of return that you can get without any default risk, that would be guaranteed for certain period of time. Investopedia says, “In theory, the risk-free rate is the minimum return an investor expects for any investment because he or she will not accept additional risk unless the potential rate of return is greater than the risk-free rate.” Ordinarily, in the United States our 3 month government t-bills act as the risk free rate, according to Investopedia.

I prefer not to divorce myself from the concept that long tail or Black Swan Events are always possible, if unlikely. By definition, risk cannot be assumed away in the real world, without ignoring unlikely events. I like them to be included in all my thinking. It forces me to always think of the downside. I am fairly risk averse. I look for a margin of safety, because I am likely at some point, to be wrong, or not have analyzed some aspect of an investment correctly.

In a post on Investing Risk, I laid out a couple of ideas concerning investment risk, including the concept that there are some risks that we may not know, or anticipate. Because we are unaware of a risk does not mean it doesn’t exist. That is the problem with risk free rate, it assumes away the unknown, or unknowable. That does not mean risk has disappeared, just that we are ignoring it.

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In their landmark book on Investing, Security Analysis, Ben Graham and Dodd describe intrinsic value in its opposition to market value. The notion of market value is clear: what the market is offering for the company today. However, intrinsic value takes a bit of work to tease out. I found the definition of intrinsic value at both investopedia and wikipedia unsatisfying. Graham describes it like this, “that value which is justified by the facts e.g., assets, earnings, dividends, definite prospects.” While the modern notion of this has been mostly relegated to Discount Cash Flow Models or “Owner Earnings,” if you follow Buffett, Graham had a more broadly based idea of Intrinsic value. You may value a company on Assets if it you are looking at traditional Net Net companies, or future earnings if you consider yourself a fundamental investor, or ability of a company to generate dividends if you are an income investor.   Ultimately, you have a value of the company that is apart from price of the stock.

Ideally, you would only buy stocks whose market price is below its intrinsic value/ share. And commonly when the price of the stock reaches its fair value, or intrinsic value you might sell. Of course if the intrinsic value of a company keeps rising, you could also continue to hold it.

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Ken Fisher, son of Philip Fisher,  in his book Super Stocks  showed that a low Price to Sales was predictive of future stock appreciation. He later claimed that it was it no longer useful because of its widespread adoption as an investment strategy.

P/S is not a metric I use, but if you choose to use it, do so with caution. It has some issues.

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