Value Trap and Margin of Safety

This "Margin of Safety" concept popularised by Benjamin Graham has hurt many "so called newbie value investors".

Not that the theory or concept is bad; it's great!

What could be wrong in buying something with an "intrinsic value" of $1 for 60 cents?

And If I ask where did you get that "intrinsic value"?

99% of these newbie value investors will answer:

From sell side analysts.

From financial bloggers (Don't look at me).

From investing forums.
 
And so on. 

Only 1% (I am making this up as to write 99.9% is a bit too strong a poke) makes their own calculations - from the raw data found in the annual reports.

I understand. Everyone busy. Everyone no time mah. So reading summaries from others is a great time saver; not to mention savings on mind power too... 

If we can, outsource! Especially when these summaries are free!

Wait a minute... Free means anyone and everyone can get a copy too!? Where's my edge then? Or am I the sheepie?

When we bought at 60 cents, let's be honest. No one buys when they think the price will keep on dropping right? 

We buy when we are afraid if we do not act now, some idiots will out-bid us and the "great value price" will run away from us; causing us to miss the boat.

Guess what? If it's great value price at 60 cents, it would be even greater value at 50 cents! Average down! I can't believe my good fortune!

And songs of rapture start breaking out as the price breaks down further to 40 cents. Average down some more! Those silly panicky sellers! I take advantage of their fear! I drink the blood they spill! Bur-ha-ha-ha!

If price drops further... 

The faithfuls will cling on the holy "intrinsic value" which they have anchored their beliefs so far. 

That is until the sell-side analysts came out with their revisions... Citing massive deterioration on the company's fundamental outlook or internals, the revised "intrinsic value" is now 40 cents. Horrors upon horrors!

Since we got these reports for free, we are at the bottom of the information food chain. The most favoured clients of these sell-side analysts are the ones selling to us @##%&*%$!@$!!

All of sudden, the "value prices" we paid don't have much Margin of Safety anymore... 




Self learning from past experience (knowing who I am)

Since I have no clue how to calculate "intrinsic value" on my own, to protect myself, I use my own definition of Margin of Safety:

It's the price I paid versus the current market price.

If I bought at 60 cents and the price rose up to 65 cents, fantastic! I now have my 5 cents Margin of Safety! (OK, you can start laughing at me now - all you true blue value investors)

If price starts to reverse, I can still get out without a loss. I hope!

It's something real; something I can see and touch. It's about here and now. No theory; no hoping. No guessing; and no forecasting.


And if I bought at 60 cents and the price drops to 55 cents, my finger would be on the sell cut-loss button. 

Sell and re-enter at a lower price if I still believe in the trade.

And if I am stopped-out on the 2nd re-entry, well, the market is trying to tell me something!

Unless of course I think I know something the market doesn't. I think not!

Sometimes it's better to just admit I am wrong (or too early) and stand on the sidelines. And wait for clarity and a better price entry point.

Take care of the downside. The upside will take care of itself.




Value Trap

What's that? Again my own non-textbook definition:

It's the mistaken belief I know more than the market about the "value" of a company's stock, the sector, the industry it operates in -  when all the information I'm basing my thesis on are written summaries from others.