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NEW DELHI: Information is key to winning in value investing, says Stephen Penman, an authority in value investing.
The professor of security analysis at Columbia University says getting enough information to understand a business and how that is going to translate into a financial statement is key.
Information reduces uncertainty and risk in investing.
Hence, the crux is to get information.
The target of the information and value investing is to discover a price that is different from value, Penman said in a interview with ETNow.
“As Benjamin Graham said: price is what you pay and value is what you get.
This is active investing, which is different from buying a passive index fund, where you buy a basket of curious stocks and you are exposed to the risk in those stocks,” he said.
The concept of value investing was first introduced by Benjamin Graham and David Dodd in 1920s.
Penman said information can help investors steer away from value traps.
“You get caught in a value trap when you see good companies and you think you will buy good companies.
But you do not buy good companies, because good companies can be bad buys.
There are firms that trade in low multiples and low price to earnings (P/E) ratios and price to book (P/B) ratios, for example, which eventually turn out to be not-so-good investments,” Penman said.
Penman explained further while buying risk, one needs to understand the difference among pricing, P/E ratio and a good P/E ratio.
“Price to earnings ratio is based on growth.
While you are buying growth, one of the mantras of value investing -- as Benjamin Graham says – is to be beware of buying growth because growth is risky.
Buying a price multiple is buying growth and you need to be beware of the risk.
Therefore, it is a deep analysis of risk as well as what the earnings payoffs are going to be which is what is key,” he said.
Asked to differentiate between value investing and growth investing, Penman said both are misnomers.
“It's fuzzy thinking.
All investing in my mind is value investing.
I can buy good value in growth.”
He said the margin of safety is important and investors need to understand the risks -- both business risks, investing risks.
He said the primary risk of investing is the risk of paying too much: overpaying for an investment is the key risk.
“So, finding stocks where the value is less than the price is very important, and that is the first step to dealing with risk and that is the margin of safety,” he said.
