There are plenty of articles on what value investing is all about. Below I explore at a foundational level what is value investing and three major factors that allow the investor to define what value is:
Supply
Labor
Market
I elaborate more on these below. As a side note, if you haven’t subscribed already, please do. You wont want to miss next weeks article on “Common Misconceptions About Value Investing”
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What is value?
Fundamentally, this is one of the most challenging and important questions to answer. What constitutes value, how do you find it and how do you find it cheaply? If you know what value is, how to find it and how to get it at the right price, you are on our way to becoming a very successful investor. No matter the industry you invest in (real estate, art, bonds, equites, private, public, minerals, pawn shops, etc.) you must be able to identify what in that industry or investment is valuable and if you are paying too much for that value as to dilute your return.
The Housing market in America is at it is most insane. One real estate agent I know personally mentioned to me in his 40+ years as a realtor, he has never seen inventory this bad, approaching a two-week supply. If you can find inventory to sell, it is a great time to be a realtor in most of America, maybe the best in this century so far. But, amongst all the noise and the buying and the selling, are their fundamental reasons why the market is this hot? And do those reasons produce value for investors.
I mention real estate because it is one asset that everyone needs. Everyone needs a roof over their head. Other than the utilitarian value of real estate, what drives its value? A home is essentially just wood, drywall, a foundation, a roof, etc. which only depreciate over time. The individual parts that make up a house are worth less than the house assembled. Other than materials, you need labor to assemble the materials and you need a market to sell the homes. Without supply, labor, or a market you cannot have value.
Since this is the case, home prices are driven by availability of supply (which is limited in material and in already built homes), availability of labor (which is also limited) and the willingness of market participants to spend money (which is limited as well). All these factors can fundamentally drive the value of homes and when multiples of these factors work together can create great price appreciation. But what has driven the rather exorbitant low levels of inventory (supply), the shortage of labor and a seemingly irrational market? I think the answer is primarily financing. With almost no need for any cash to get into a home and the lowest rates this nation has ever seen, an environment has been created where people need no skin in the game to buy a home and no worries about obtaining the needed capital.
I believe these are rather non-fundamental reasons that home prices are driven higher and higher. Mortgage interest rates and underwriting requirements are not dependent on the housing markets itself like supply and labor are but on arm-length regulators.
At risk of making this article all about real estate, I digress. It is a good example to help illustrate what value is, though. Value is a combination of available supply, available labor, available market capture and each companies’ ability to capture the market. In other words, value is a combination of assets (supply), product (labor), and growth (market capture).
I don’t think this simple definition can be stressed enough. Value investing is a broad field and encompasses every industry and asset class. It is even broader than much of the “growth” investing that takes place in the market today.
What is a value investor?
Essentially a value investor whether he mentions these factors especially or not is seeking favorable supply dynamics, a labor force that can turn the available supply into a product hopefully better than anyone else, and a market that needs the product the labor produces.
If you find an investment that can meet those three criteria well you are almost certain to have a good investment on your hands.
***While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.***