The first investment session
Foundational Knowledge for Long-Term Value Investing
Business & Accounting Literacy (The Language of Business)
- Understanding Financial Statements:
- Income Statement: Tells you about profitability over a period. (Revenue, Cost of Goods Sold, Gross Profit, Operating Expenses, Net Income).
- Balance Sheet: A snapshot of assets, liabilities, and equity at a specific point in time. (Assets = Liabilities + Equity). Understand concepts like working capital, debt levels, book value.
- Cash Flow Statement: Tracks the actual cash moving in and out of the company, categorized into Operating, Investing, and Financing activities. Often considered the most crucial by value investors as "cash is king."
Key Financial Ratios & Metrics: Learn how to calculate and interpret ratios to assess profitability (e.g., Gross Margin, Operating Margin, Net Margin), efficiency (e.g., Asset Turnover), solvency (e.g., Debt-to-Equity, Interest Coverage Ratio), and returns (e.g., Return on Equity (ROE), Return on Invested Capital (ROIC)). Understand what makes a "good" number in context.
Accrual vs. Cash Accounting: Understand the difference and why cash flow can sometimes paint a truer picture than net income.
Microeconomics & Business Strategy
Competitive Advantage (Economic Moats): This is central to Buffett's philosophy. Understand what gives a company a durable edge over competitors (e.g., network effects, intangible assets like brands/patents, cost advantages, switching costs). Learn to identify and assess the strength and durability of these moats.
Industry Analysis: Understand the dynamics of the industry a company operates in (e.g., Porter's Five Forces). Is it growing? Is it fragmented or consolidated? What are the key risks and opportunities?
Business Models: How does the company actually make money? Is the model sustainable and scalable?
Management Quality: Assessing the competence, integrity, and shareholder-friendliness of the management team is crucial, though often qualitative. Look at capital allocation decisions, communication, and track record.
Valuation Principles
Intrinsic Value: The core concept. Understand that a stock's price is what you pay, but its intrinsic value is what it's truly worth based on its underlying fundamentals and future cash flows. Value investing aims to buy below this estimated value.
Discounted Cash Flow (DCF) Analysis: Conceptually understand how to project future free cash flows and discount them back to the present value. While precise DCF is hard, the concept is vital.
Valuation Multiples (Relative Valuation): Understand metrics like Price-to-Earnings (P/E), Price-to-Book (P/B), Price-to-Sales (P/S), EV/EBITDA. Know how to use them intelligently – comparing apples to apples and understanding why a company might trade at a certain multiple. Don't use them blindly.
Margin of Safety (Benjamin Graham): The cornerstone of risk management in value investing. Always seek to buy assets at a significant discount to your conservative estimate of their intrinsic value. This provides a buffer against errors in judgment or unforeseen negative events.
Market History & Psychology
Market Cycles & Volatility: Understand that markets move in cycles, and significant downturns are inevitable. History provides perspective.
Behavioral Finance: Recognize common cognitive biases that derail investors (e.g., herd mentality, confirmation bias, overconfidence, loss aversion, anchoring). Understanding these helps you avoid them in your own decision-making and potentially exploit them when others succumb. Mr. Market (Graham's allegory) is a key concept here.
Preliminary Investment Framework
Define Your Investment Philosophy & Goals
- Be specific: Are you looking for deep value (statistically cheap stocks, potentially lower quality), quality companies at a fair price (Buffett's evolution), or growth at a reasonable price (GARP)?
- What are your financial goals (e.g., retirement, wealth preservation)?
- What is your time horizon? (Value investing requires a long horizon).
- What is your genuine risk tolerance (not just what you think it is, but how you'd react in a crash)?
Develop Your Idea Generation / Screening Process
- How will you find potential investments?
- Quantitative screens (e.g., low P/E, high ROIC, low debt – using financial data providers).
- Qualitative sources (e.g., reading business news, industry reports, observing the world around you – Peter Lynch style, analyzing holdings of respected value investors).
- Define your "circle of competence" – industries and businesses you can genuinely understand. Stick within it.
Establish Your Research & Due Diligence Process
- What steps will you take once you identify a potential idea?
- Reading annual reports (especially 10-Ks in the US), quarterly reports, investor presentations, earnings call transcripts.
- Analyzing financial statements and calculating key metrics.
- Assessing the competitive landscape and moat.
- Evaluating management.
- Formulating your own independent view of the business's prospects.
Determine Your Valuation Methodology
- Which valuation tools will you primarily rely on? (e.g., focus on earnings power value, DCF, asset value, relative multiples). Be consistent.
- How will you estimate intrinsic value? Be conservative in your assumptions. Define a range rather than a single point estimate.
Define Your Margin of Safety Requirement
- How much discount to intrinsic value do you require before buying? (e.g., 30%, 40%, 50%). This might vary depending on the perceived quality and predictability of the business.
Portfolio Construction & Risk Management Rules
- How many stocks will you hold? (Concentrated vs. Diversified – value investors often lean towards concentration, e.g., 10-25 stocks).
- How will you determine position sizes? (Equal weighting, conviction weighting?). Never bet the farm on a single idea.
- Define your selling criteria: When will you sell a stock? (e.g., Price reaches/exceeds intrinsic value, fundamentals significantly deteriorate, found a much better opportunity, made a mistake in initial analysis). Avoid selling purely based on price declines if the underlying value remains intact.
- How will you handle cash? (Hold cash when opportunities are scarce?).
Commit to Continuous Learning & Review
- Keep a journal of your investment decisions, including your reasoning at the time.
- Review your mistakes honestly. What went wrong? What can you learn?
- Keep reading, learning about businesses, and refining your framework.
Recommended Books
- 《The Intelligent Investor》 by Benjamin Graham (Specifically the revised edition with commentary by Jason Zweig)
- 《Security Analysis》 by Benjamin Graham and David Dodd (Specifically earlier editions like the 2nd or 6th)
- 《The Essays of Warren Buffett: Lessons for Corporate America》, Edited by Lawrence Cunningham
- 《Common Stocks and Uncommon Profits》 by Philip Fisher
- 《Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor》 by Seth Klarman
- 《You Can Be a Stock Market Genius》 by Joel Greenblatt
- 《Financial Statement Analysis & Security Valuation》 by Stephen Penman
- 《Thinking, Fast and Slow》 by Daniel Kahneman
- 《The Psychology of Money》 by Morgan Housel
Approaches for learning
- start with Concepts
- build technical skills: accounting and financial statement analysis
- read widely
- practice
- patience