Value Investing

 

The Gabelli School of Business offers a three-course secondary concentration in value investing, designed by finance professor James R. Kelly. Students who want to pursue this concentration must take the first course, Introduction to Value Investing, beginning no later than the second semester of junior year.

 

What is value investing?
Value investing is a time-tested and proven investment methodology that is fundamentally different from conventional security analysis.

It focuses on determining the intrinsic value of a company based on its current and historical balance sheets, income and cash flow statements. The element of future growth is considered a positive characteristic only if it comes from sustainable competitive advantages within the franchise of the company due to the existence of barriers to entry. An investment in a company is worthwhile only if there is a significant margin of safety between the company’s intrinsic value and its market price.

The Discounted Cash Flow (DCF) method, in contrast, is based on discounting future cash flows projected from the current income and cash flow statements back to present value using an appropriate cost of capital. The balance sheet is frequently de-emphasized or ignored in the valuation process.

 

Structure of the secondary concentration
The value investing concentration consists of the following three courses:

  • Introduction to Value Investing (FNBU 4457)
  • Behavioral Finance (FNBU 4458)
  • Advanced Topics in Value Investing (FNBU 4459)

Pre-requisite for the introductory course: Financial Management
Co-requisite: Global Financial Statement Analysis

 

Value investing coursework

Introduction to Value Investing
Objective: Students will learn how to identify, analyze and compare undervalued companies that offer a significant margin of safety to their intrinsic value. The methodology of analysis is as follows:

  • The students will begin with an analysis of the balance sheet, adjusting each line item to current market replacement value for viable businesses (or liquidation value in the case of non-viable businesses) and then calculate an adjusted net asset value (NAV).
  • They will then analyze the income and cash flow statements to determine the earnings power value (EPV) of the company through an analysis of its sustainable operating earnings over a business cycle.
  • These sustainable earnings are then capitalized using an appropriate WACC to calculate the EPV.  The students will then compare the adjusted NAV and the EPV to identify the reasons for any differences in valuation and to determine the franchise value of the company. They will then analyze the value of growth, if any, and determine the total intrinsic value of the company.
  • The final step is for the students to compare the intrinsic value to the market value to determine if there is a significant margin of safety to justify an investment.

 

Behavioral Finance
Value investing is very closely intertwined with behavioral finance. Swings in investor psychology by the emotional “Mr. Market” explain why stocks can trade far below, or far in excess of, their intrinsic value. Behavioral finance challenges the precepts of the Efficient Market Theory, which is based on the belief that investors make rational, predictable and non-emotional decisions. Behavioral finance suggests that investors act on the basis of heuristics and not on elaborate rational models, and that there is a need to understand the psychological roots of decision-making in order to explain many anomalies and puzzles.

Objective: Students will study these behavioral anomalies to gain insight into the psychological underpinning of investor behavior and asset prices.

 

Advanced Topics in Value Investing
Objective: Students will study a variety of advanced topics that draw on the principles outlined in Introduction to Value Investing and Behavioral Finance. They include:

  • Mario Gabelli’s Private Market Value with a Catalyst : “We define Private Market Value (PMV) as the value an informed industrialist would pay to purchase assets with similar characteristics … Our goal is to identify companies in the public market that are selling at discounts to their intrinsic or private market value. A catalyst may take many forms and can be an industry or company-specific event. Catalysts can be a regulatory change, industry consolidation, a repurchase of shares, a sale or spin-off of a division, or a change in management.” (Gamco Investors, Inc. web site, www.gabelli.com, Value Investing – US)
  • Warren Buffett’s Capital Allocation principles: “Buy good or excellent businesses at a reasonable price …  (companies) with strong franchises, above-average returns on equity, a relatively small need for capital investment, and the capacity to throw off cash … and stay within (your) circle of competence.” (Warren Buffett)
  • Distressed Investing: Distressed debt, especially the bonds of companies in default, can be mispriced because of forced sellers and missing buyers, due to suspension of interest payments and uncertainty over principal repayment.
  • Merger Arbitrage: The existence of a discount before closing between the market price of the target company and the bid price can present a value-investing opportunity.

 

For more information about the value investing program at the Gabelli School, students should see their class dean for prerequisite and course registration information.