The Business of Value Investing.pdf

22 The Business of Value Investing

understand the business. And to understand a business, you should

really know it. Simply reading the annual report is the beginning.

In order to understand the business, you should also be familiar

with the industry the business operates in, the competitive forces

within the industry, and how any external business threats could

affect the business going forward. If you can ’ t understand the busi-

ness, you can ’ t make intelligent assumptions about its future cash

fl ows or anything else that might be meaningful to assessing the

value of the business.

Realize that you do not need to understand every indus-

try in the business world; it ’ s far better and more rewarding in

the long run if you can understand a few industries exception-

ally well. Develop a core competency in a few areas, and you will

fi nd plenty of opportunities to make money. Buffett ’ s core com-

petency is the insurance industry; he understands all the ins

and outs of the insurance business and has used his expertise

to great success. Also remember that Buffett has been investing

for over 50 years, so developing an investment acumen does take

time and it ’ s an ongoing process. Focus on what you can under-

stand, and read as much as you can. Over time, the competency

will develop and serve as building blocks for different investment

opportunities.

What exactly do I mean when I call a business undervalued,

overvalued, or fairly valued? As the goal of investment success

hinges on fi nding discrepancies between market value and busi-

ness value, it is more precise to refer to an investment as under-

priced, overpriced , or fairly priced. An undervalued business is one in

which the underlying stock price is underpriced. Why get so tech-

nical with the wording?

Just because a stock price is cheap does not mean that the

underlying business is undervalued. Conversely, an underval-

ued business does not have to be a cheap stock. When seek-

ing to defi ne value - oriented investments, many academics and

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