Saturday 31 August 2013

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.


  1. Hope you are safe from counterstrike by Value Bombers. :-)

    1. CW,

      1) There is a reason why I didn't write this post not on my 1st, not on my 2nd year, but only on my 3rd year of blogging.

      Regular readers will know where I come from. I'm not an investor. I'm more a trader trying to learn how to sit still.

      2) For new readers, before throwing the first stone, try explaining with all the "free" information out there, why do you think mutual and hedge funds "invest" in having their own buy-side analysts? Which side has more skin in the game?

      Why do Warren Buffet and Peter Lynch comb through annual reports directly when they can read sell-side analysts' summaries instead?

  2. Hi SMOL,

    Instead of sell-side analysts, I pay more attention to the buy-side (analyse bloggers?) instead. Think it slightly improves matters?

    I don't really spend too much time analysing the numbers and coming up with an intrinsic value as I feel it's really easy to doctor the numbers if the management has the intent.

    60 cents for a dollar? They could just run away with your 60 cents and never come back!

    Investing for retail investors is actually a probability game and one must be prepared to lose sometimes. So better for me to diversify (15-20 stocks) since I am never really too sure.


    1. Quoting ...

      "Less Analyzing. More Investing." - Createwealth8888


    2. Stoical Keynes,

      Have you visited Valuebuddies?

      You may notice the veterans there when answering questions from newbies, often quote from annual reports, citing which page and on which paragraph - even from the appendixes!

      This is proof real value fundamental investors do exist - but not in abundance ;)

      Value investing is hard - it's not for the lazy like me.

      Most retail investors belong to 3 broad categories:

      1) Buy on rumour or tips kind (what stocks can I buy huh?)

      2) Technicians (can't read but can see pictures mah!)

      3) Growth Fundamental investors (buy high hope to sell higher)

      If I always buy at near 52 weeks high, I can call myself Growth, Momentum, Trend Following, or whatever names I like except Value investing.

      True blue value investors will know I am paying homage to them in my post above ;)


    3. No prizes guessing which group I belong to.

      With my limited education, I stick with pictures, ang kongs, cartoons, etc.

      Although I must say believing in technicals is like believing in voodoo!!??

      It's helpful provided you don't become superstitious!

  3. Another class of investors not commonly known in the market - "Patient and Lazy" investors.

    1. CW,

      That's because how many can sit still with a stock for 20 plus years!!! You and your Keppel... Ha ha!

      Hmm... Maybe I should buy you coffee at Kovan for the secret.

      On 2nd thought maybe not. Wait you just give me a tube of Mopiko as the answer ;)

    2. My answer to itch is not Mopiko. It is this one leh:

      Medicated Oil

      Don't go to field camp or nature reserve without it.


    3. CW,

      No wonder your investor class is not commonly known.

      I've never heard of Eagle brand medicated oil... I am more mass market - Axe brand, White flower brand, Tiger Balm, etc; I know.

      Dang! Even the medicated oil I use is not "special". There goes my illusion of having an "edge" over others...


      Helicopter just crashed down to ground zero.

    4. Actually Eagle brand is quite famous leh.

      I averaged down on Keppel. Now I think I must learn to sit 20 years and wait for the east mountain to come back. :\

    5. Rainbow mei-mei,

      I've no clue about this strange green coloured Eagle brand until I watched the Chinese documentary recently.

      Singaporean medicated oil invented by German? Who would have guessed!

      I've learnt the hard way its better to average up than average down.

      Trading's language more colourful:

      Always add to winning trades; never to losing ones.

      This one by Paul Tudor Jones is even more powderful:

      Only losers add to losers :(

  4. Whatever.
    Mr. Market will tell you the Truth sooner or later. Meanwhile, don't trust what Mr. Market is telling you now. Or even trust yourself what you think you know about the Market now. It's always after it happens then you can be sure.

    1. temperament,

      I stalk the value investors at Valuebuddies to learn their thought processes.

      I don't think these bottom-fishers will bite at STI 3,000. Their target is much lower.

      Those who bought at 3,000 are buy-the-dippers traders. And they got their $ when STI bounced from just below 3,000 to 3,045 last week (ahem, I joined into that kopi $ trade too).

      I trade what the price action tells me. It's the here and now Zen sort of stuff.

      For investing, I just got lucky in 2009 despite being late. Nothing to see here. Everyone move on.


  5. if you ever drink kopi at Kovan, message me and I will walk over to join you


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