THE BLACKBOARD

Value speak for the uninitiated

Investors who are new to us often ask about some of the concepts that we tend to employ in our letters and presentations. What follows are some informal definitions which should help understanding the logic behind our thinking.

02 · 11 · 2017
JUAN Cantus

3 minutes

It is worth adding that for each of the concepts explained below we should probably say “for us”, but to save on repetitions we have avoided doing so.

Share: The ownership of companies listed on the stock market is divided into shares. When we buy shares, we own a part of a company. When a company’s value increases, its share price also usually ends up rising.

Target price (intrinsic value): The value that we believe the company would have in the eyes of well-informed investors under normal circumstances, divided by the company’s total number of shares.

Upside: The difference between the share price and the target price (intrinsic value). For example, if we value a company at €19 and it is trading at €10, we say there is 90% upside.

Margin of safety: How much room we have to get it wrong before losing money over the long-term. In the previous example, we have a €9 margin before suffering a permanent loss. The is the key value concept and is probably the reason why value investors get a better night’s sleep than anyone else working on the stock market.

Long-term: The patience needed to turn the upside into a reality. Companies which are cheap now, won’t be someday in the future. By being patient, we grow our wealth.

Expected yield (or return): The result of dividing the amount a company is capable of earning in a normal year (neither good nor bad) by its market cap (number of shares multiplied by the price at which shares are trading) plus debt and other adjustments. For example, a yield of 12% means that on average a company will be able to generate 12 euros per year for every 100 euros that we invest, assuming we were to buy it in full at the current share price.

P/E ratio (price/annual earnings): The number of years needed to recover our investment. In contrast to the yield, the P/E ratio does not take account of the company’s level of net debt.

Don’t be left in the dark, we like being understood

Circle of competence: Companies we understand and can place a value on with a high degree of confidence.

Quality: A company’s capacity to keep generating high earnings for every euro invested in its business over a sustained period.

ROCE (Return on Capital Employed): The earnings a business generates for each euro that it has invested in doing so (machinery, offices, stock, etc.). This is one of the tools we use to judge the quality of a business.

Investment: Transactions which, based on careful analysis, carry a very low likelihood of losing money and where an attractive return can probably be attained over the long-term.

Speculation: The opposite of an investment. A transaction without a sufficient margin of safety. We give speculation a wide berth; we don’t mess around with our clients’ money.

Portfolio (or “fund”): The set of investments we make. Nobody is infallible, so we undertake various investments at the same time (generally over forty) to ensure that the good ideas vastly outnumber any possible errors.

Weight in the portfolio: The percentage of the fund’s total assets which are invested in a specific company. The main factors determining a company’s weight in the portfolio are the upside, yield, business quality, our degree of conviction and the size of the company itself. The regulator (CNMV) also requires us to have a very diversified portfolio.

Net asset value (NAV): The price at which the fund is trading. It goes up and down…we can’t do anything about it, except improve the fund by continually seeking out good companies at the cheapest possible prices (the essence of what we do) and wait patiently for others to buy them off us at more reasonable prices.

But more than everything we have explained above, don’t be left scratching your head. We like being understood. Sometimes we focus so much on unearthing and analysing good companies, and dive so deep into the details that we overlook the importance of clear communication. Don’t hesitate to ask us about any concepts we are using that you don’t understand. We would be delighted to clear things up.

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