In Friday's post Fundamentals Vs. Indicators I attempted to explain how I use both fundamentals and indicators (sentiment and technical) in my investment process. A reader asked me to elaborate further on my fundamental process and I will attempt to do so in the next few posts. Most value investors fall into one of two categories. There are value investors whose main focus is the balance sheet and there are those whose main focus is the cash flow.
Seth Klarman is probably the best value investor right now and he is what I refer to as a "balance sheet" investor. He looks for situations where he can buy $1 of assets for 50 cents, even if its uncertain how or when that value will be unlocked.
The other type of value investor is a "cash flow" investor, the most famous being Warren Buffet. Warren Buffet is more interested in buying companies that generate and will likely continue to generate good cash flow at a reasonable multiple than buying assets on the cheap. In his earlier years Buffet was more like Klarman but he slowly shifted to a cash flow investor. That might be because it gets more difficult with size to be a "balance sheet" investor as many of the assets are illiquid and hard to accumulate in Buffett size quantities. Also, reinvestment of assets is much more of an issue as well.
I fall into the category of a "cash flow" investor. Balance sheet investing makes perfect sense to me but requires a greater leap of faith. The assets are usually less liquid and the how and when value will be recognized is often an unknown. Taking that leap of faith is why investors like Seth Klarman get paid but there is money to be be made in value investing based on "cash flow" as well.
TO BE CONTINUED...