DKAM-final newsletter5-a

4 4 2 ROE REPORTER | DKAM We view value traps in three ways: 1) The cheap stock declines after buying it, but because the reason to buy it in the first place was that it was cheap, price declines only make it cheaper and hence more attractive. High quality companies, that possess defensible moats that lend themselves to compounding, aren’t the type of stocks that can be found in the bargain bin. 2) A value investor may know what he/she believes the company is worth – say it is trading at $10/share and they think it is worth $15/share. What they don’t have however, is an investment horizon or any real idea of the time it will take for the stock to reach fair value. 3) When, or if, the value of the stock is realized, the value investor sells, realizes the gains, pays the tax man and then has to find another investment idea. All of this is why value investing doesn’t lend itself to successfully compounding capital. Most of the issues with value investing relate to time, specifically investment horizons. If someone invested in something purely because it is cheap, then they are at the mercy of the stock market. For the gap to close between the market value and the fair value, there needs to be an event that changes the minds of the market participants. And unless they’re an activist investor, this event is out of their control and now they’re playing the waiting game. Each day that goes by, their annualized return decreases. This type of investment would make it hard to sleep at night because of the uncertainty of how the market will treat the investment and when the thesis will play out. Hope is not a strategy. However, we invest in high ROE companies because they’re continually increasing their intrinsic value…even if we don’t know when lightning will strike the clock tower. OUTATIME Let’s revisit the second of our original time related questions, knowing when to exit a specific stock. When we invest in a company, we don’t do it with an exit in mind. Just like Buffett, we plan on holding and allowing the magic of