In the last four articles, we looked at what the stock market is, why companies list, how stocks trade in the stock market and why we need to invest in the first place. The next four articles, including today’s, will concentrate on looking at investing from a business perspective, among others.
When you flip open the “Money” section of the Straits Times, you can find the previous day’s prices of blue-chip companies. SIA Engineering Company Limited closed at $4.98 on 5th July 2013. The 52-week high price was $5.32 and the 52-week low price was $3.98. How come there are such huge changes in the price within one year? Can the value of the SIA Engineering business change so much within one year? Certainly not. The stock price moves according to the buyers and sellers in the market (supply and demand) but the value of the business does not change every second, like the stock price. Stock price is not equal to value of the business. Paying too high a price for too little a value is not prudent. In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.
Benjamin Graham mentioned that, “Investment is most intelligent when it is most business-like.” How do we do approach stock investment from a business perspective? We can do that by analysing the competitive advantage of the business, the financial statements of the business, the competence of the management and looking into the intrinsic value of the business. By having a business approach, the analysis of the business would not be hampered by the daily stock price fluctuations and we will be able to make a sound judgement.
Let’s imagine SIA Engineering is not a listed company but you are keen to invest in it. You have looked into the business, how it makes money and you deem this is a sound business. However, since the company is not listed, how do we know how much to pay to purchase the business? In other words, how would we know the value of the whole business?
To know the value, we would need to look at the financial statements and come up with an intrinsic value of the business. Intrinsic value is the summation of the future cash flow discounted to the present value. With this figure, we would know how much the business is worth and how much we have to pay for it.
Now, since we know that SIA Engineering is indeed a listed company, we can check out the current trading price from the SGX website. We can then compare the current price to the intrinsic value of the business. If the intrinsic value is much higher than the current price with a huge margin of safety, we can safely buy into SIA Engineering. This is how to approach buying a stock from the business perspective.
Calculating and knowing the intrinsic value of the business we are buying into also allows our emotions to be in check. When the price of SIA Engineering drops after buying and the fundamentals of the business have not changed, we can purchase more of the company at a cheaper price and wait for the share price to appreciate.
On the other hand, purchasing a stock by looking at the 52-week high or low is not the right way to approach stock investing. The 52-week high or low says nothing about the intrinsic value of the business.
Furthermore, when investing, we need to have long-term view of five to 10 years. Businesses take time to grow and they do not flourish overnight. It also helps to imagine that the stock market will be closed for the next five to 10 years years and that our entire family fortune depends on this company doing well. By having this mindset, we will not speculate on stocks.
In summary, stock market investment is not merely buying pieces of paper with the prices fluctuating daily. We should always remember that behind the stock price and the ticker symbol, there is an underlying business.
To know more about Value Investing …….
Sudhan, Business Analyst
Mind Kinesis Value Investing Academy