Value investing is not easy

I consider myself a value investor. Though logically simplistic, value investing is challenging because it requires you to be patient. There are five major areas I personally evaluate:

1. This includes such things as price-to-cash flow, intrinsic value and liquidated value. Is free cash flow growing? Is operating cash flow consistent? Is there enough margin of safety?

2. What’s the return on capital and return on equity? It’s hard to have a good investment if for the long term, the company does not have a good return on capital or equity. But you also can’t overpay.

3. What are the management team members like? Are they competent, honest, experienced and effective? Management that aligns its interests with those of the shareholders is best.

4. Companies that grow faster have the ability to obtain more market share and being sizeable may create more value. Sometimes, however, larger organizations don’t always make the best decisions. Ideally, I like to buy stocks where the growth rate is equal or higher than the price-to-earnings ratio. Many refer to this as the price-to-earnings growth ratio.

5. Look at a company’s debt and understand the balance sheet. Companies get in trouble if they have too much leverage and aren’t good stewards of their resources. There are three major types of risk to consider: valuation, leverage and business.

There are four special situations to consider. First, insider buying is a significant indicator. There are many reasons people sell, but one reason people buy. Next, share buybacks. They outperform on average, especially when buying back their stock when it’s inexpensive. They create value when inexpensive and dilute value when expensive.

Third, look for companies that have increased dividends. In some cases large, special dividends can be just as advantageous since shareholders receive a significant return without management or overpaying for shares. Fourth, activism. Are any successful activists involved? On average, they also outperform the market. They can help create value by unlocking value with various strategies and by addressing important issues.

Learning is like money. It compounds. We all have to be committed to lifelong learning, be it in investments, business or whatever. If you have the passion and desire to learn from life experiences and those of others, including both successes and failures, there are enormous amounts of resources available to become an aggressive or enterprising investor.

If you are not willing to invest a significant amount of time and effort to really learn, you should take a more passive or defensive approach to investing.

Achieving a good investment record takes much study and work and is a lot harder than most people think. I wish you good fortune on your journey of learning to become a better investor.

Umberto P. Fedeli is president and CEO at The Fedeli Group