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Value investing, perhaps the most sophisticated term in the stock market, mainly because all the celebrity investors, including Warren Buffet, Charlie Munger, Bill Ackman, seem to call themselves value investors.
But who is a value investor, and what is value investing? Well, in layman’s terms, value investing is just buying a valuable company at a discounted price or below its intrinsic value. And a value investor is someone who does that, of course.
Now, there are a lot of resources online where you can learn value investing and other things like how to find the intrinsic value of a company, but that is not the topic of this blog.
What we are discussing today is a secret method that allows you to invest in value stocks at a discounted price that is not available to the retail investors, and the best part is, you get paid even if your market order doesn’t go through.
Obviously, not a lot of investors know about this, and they shouldn’t. Because if a lot of people started doing this, then this strategy might stop working as well. So this time, we might recommend you not to share it with all of your friends.
Now, we are not the inventors of this strategy. This belongs to Matthew Peterson, managing partner at Peterson Capital Management. You can visit their website to know more about them.
So enough of build-up, let’s get to the strategy!
The Secret Method to Value Investing
Before understanding his method, we need to understand what Matthew does at his fund. Peterson Capital Management is a long-term value fund that is very concentrated on a number of parameters.
The basic framework that Matthew follows at his fund is focusing only on the greatest business models with the greatest managers or CEOs and investing in them for the long-term.
The firms they look at are very niche sort of companies that are available at a value. For example, Warren Buffet’s partner Charlie Munger runs a micro-cap tech firm called Daily Journal, where they do SaaS software implementation for courthouses. They’re only about $285 million in market cap, and a lot of people are not aware of them.
So they’re the kind of company with a great business model, extraordinary management, and no hype around them, meaning they check all the boxes for value investing. Matthew says he likes small companies a lot because they have the room and potential to become large companies.
Now the question is, how do you find such companies when there are thousands of firms listed on the stock exchanges? Well, that’s the first step of the secret method, so let’s discuss that in the next section.
1. How to Find Value Stocks
Thankfully, Matthew has a very specific process on how to find these value stocks. So you don’t have to go through the fundamentals of each listed company.
The SEC requires funds larger than $100 million to post their holdings in a 13f every quarter. A 13f is a filling by institutional investment managers listing all their equity holdings every quarter. This filling is made available by the SEC in the public domain.
The strategy is to open the SEC’s website and look up any value investing fund to see what their holdings are, and how they change quarter on quarter.
If you see that one of these big investors is piling into a new opportunity, it might worth digging deeper. You don’t have to jump onto that stock the very next day but get an idea of where the opportunity is in the market. Looking at these 13fs is how Matthew starts most of his research.
Now, if you’re looking at high-frequency trading or flipping shares, then these 13fs will be of no value because they come out 45 days after the quarter ends. But for value investing, it is a great resource.
The reason why these 13fs are so valuable is, if you look at Bill Ackman, David Einhorn, and Warren Buffet sort of investors, then these people are putting billions of dollars into a company.
And before investing their billions, they do hundreds of thousands of hours of research and spend millions of dollars to select the companies to invest in.
So when you’re studying their 13f, you’re looking at the best value stocks according to their extensive research. That’s why it’s a fascinating thing to know what these powerhouses are holding.
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2. Analyse the Stocks
In the previous step, we narrowed down your stock search from all listed companies to just 30 to 50 most interesting ones. Companies that the most successful value investors are betting big on.
But you can’t obviously go and create a portfolio including all of them because first, that would require you a lot of funds, and even if you have the funds, copying someone’s investment without your research is a really dumb idea.
So what a wise investor would do is find out why the biggies are interested in these companies in the first place. You can’t find all the reasons or the exact reasons behind it, but the goal is to find the reasons that are most justifiable to you.
Conduct a fundamental analysis of the stocks and see which of them seems most strong and undervalued to you. If you’re looking to invest for the long-term, then you just need to select 3 to 5 best of the best to create your value investing portfolio.
3. Secret Way to Buy These Stocks
Ok, so we looked at billionaires’ portfolios, shortlisted some stocks, and then did our own analysis to find out the best 3 to 5 value stocks. But that is something every investor does. Where’s the secret method? Well, the secret lies in how you buy these stocks.
Matthew has a very unique approach to how they buy securities for their fund, and you can follow that too, but just remember that shares come in multiples of 100 in this strategy.
So instead of buying your stock at the New York stock exchange or Nasdaq with a limit or buy order, we go to the Chicago Board Options Exchange and write a contract called a put. When you write a put to someone, you’re basically ensuring somebody that you’ll buy the shares from them.
It may sound complicated so let’s take an example to understand how this works. So let’s say TSLA is trading at $400, you can go and buy a share at $400 in the market, or you can go to the Chicago Board Options Exchange and write a put committing to buying it at $400.
If you make a commitment to buy till January 2022, you can get paid $175 in premium to make that commitment. This means if the share price dips and they put it in your portfolio, you keep your counterparts capital, and it costs you $225 per stock instead of $400.
And you know what’s the best part? Even if your commitment price doesn’t go through, meaning you don’t get the stocks in your portfolio, you still get paid the premium.
To sum it up in layman’s terms, it’s like buying a pork belly future but instead of having a cash delivery, you say I want the pork.
This works best when the volatility is high because when the Vix index is high, the premiums on puts are higher.
You can see this as placing a buy limit order with your exchange but also getting paid for it. What’s better than that.
Who Is This For?
Anyone can follow this strategy, however, it is good to classify a strategy based on how risky it is and what type of investor does it suit the best.
In my opinion, the strategy presented above falls in the portfolio of somebody who has a medium to lower risk tolerance.
Because if you look at it at the simplest fundamental level, what you’re essentially doing is you are lowering your purchase price, as we saw in the example of TSLA where instead of $400 a share, you can get it at $225 if you can wait for a year.
That lowers your risk because if the shares fall to $200, instead of losing 50%, you just lose 10% off your investment.