Analysis from the “four cornerstones” of investment: Is there a “value investment” in the currency circle?

Original title: “Does Value Investment Really Work in the Currency Circle?” 》

Research institution: Mint Ventures

In various Chinese encrypted investment chat groups, “value investment” is often a stubborn existence. People often use it to laugh at themselves. When an investor is stuck, he\she may say: “This is only value Invested.” Then the onlookers expressed sympathy or ridiculed a few words, and then the group was suddenly filled with happy air.

Or, value investing is like an elusive fashion trend, sometimes admired by everyone, sometimes “not worth a pile of shit”, suddenly “dead”, and soon it returns.

We also occasionally met a group of friends who self-positioned as “value investors”. When asked what value investment is, the keywords they mentioned most were “long-term holding”, “patient” and so on. In our opinion, this is not the original intent of value investing.

What is value investing?

The definition of value investing is not complicated, but it is not as simple as most people think.

The idea may first originate from the American securities investment guru Benjamin Graham and his pioneering work “Securities Analysis”, emphasizing the analysis of the investment value from the intrinsic value of stocks.

Subsequently, Philip Fisher, Charlie Munger, Seth Karaman, Howard Marx and other masters continued to contribute to the concept of value investment, making its ideological system flourish. And what really pushed the value investment system to the world and made it a buzzword is Warren Buffett, who has more than 50 years of brilliant investment performance.

So, what is value investing? Some people say that the essence of value investing is: buying something for one dollar with 40 cents, that is, buying assets at a price lower than the intrinsic value of the asset.

This statement is correct, but this is the result or goal of value investment, and how we can achieve “buying assets at a price lower than the intrinsic value of assets” is what we care most about.

Section One

The four cornerstones of value investing

In our opinion, value investing can be summarized by four key concepts, which we can call the “four cornerstones” of value investing. They are-

1. Buying stocks is buying companies

2. Ability circle

3. Margin of safety

4. Mr. Market

The above four key concepts have constructed a small universe of value investment theory. When we understand, recognize and begin to practice the above four key words, we embark on the road of value investment.

What are the specific explanations for these four concepts? Let’s say specifically–

1. Buying stocks is buying companies

The source of stock value is the ownership of the company it represents, and the company is valuable because it can create profits and cash flow. Therefore, when we buy stocks, we essentially buy and hold the ownership of the company behind the stocks. The value of this ownership is determined by the total cash flow that the company can create in the future. Buying stocks is the process of judging the value of a company’s future cash flow.

Here, the concept of “intrinsic value” emerges. The intrinsic value of a company refers to the sum of discounted cash flows that the company can create from now until the day it goes bankrupt.

*Discount: refers to the process of converting future asset prices to current prices. For example, the 10 yuan of your income in 10 years is equivalent to the current 5 yuan, and that 5 yuan is the current discount value of the 10 yuan. The discount value is also called the discounted value.

2. Ability circle

The competence circle refers to the scope of the investor’s competence. When we can truly understand an asset and have the knowledge that surpasses most investors in the market, this asset is within your competence circle. The concept of competence circle is not difficult to understand. The real problem is that people tend to be overly optimistic about their assessment of the radius of their circle of competence.

3. Margin of safety

The margin of safety is a common practice principle in daily life. For example, we have built a stone bridge with a maximum load-bearing capacity of 20 tons, and we will only allow cars with a total load of 15 tons to pass through it. The “margin of safety” set aside by the bridge.

The meaning of the margin of safety in terms of investment is to buy company stocks at a price lower than the connotative value of the company (or any other asset), which is what Buffett calls “buy something worth 1 yuan with 40 cents.”

The margin of safety is to admit that you will make mistakes and the market is difficult to predict. It is a buffer zone between your hard-earned money and your miscalculations, doom, and the economy and the market itself. The more the margin of safety is left, The more room we leave for ourselves to make mistakes, the less likely it is that we will eventually lose money.

4. Mr. Market

The concept of “Mr. Market” comes from a parable in “Securities Analysis”, as follows:

Imagine that you are trading stocks with a person called Mr. Market. Every day Mr. Market will definitely propose a price at which he is willing to buy your stock or sell his stock to you. Mr. Market’s mood is very unstable. Therefore, on some days Mr. Market is very happy, only seeing the beautiful days before him, then Mr. Market will quote high prices. On other days, Mr. Market was quite depressed, only seeing the difficulties in front of him, and the price quoted was very low. In addition, Mr. Market has a lovely feature. He doesn’t mind being ignored. If Mr. Market’s words are ignored, he will come back tomorrow and make his new offer. What Mr. Market is useful to us is the quotation in his pocket, not his wisdom. If Mr. Market does not look normal, you can ignore him or take advantage of his weakness. But if you are completely controlled by him, the consequences will be disastrous.

Mr. Market reports only the price of assets, not the value of assets. The price is what we pay, and the value is what we buy.

Combining the above four concepts, we can come to the definition of value investment: in our ability circle, buying assets with a price lower than the connotative value of the asset and leaving a sufficient margin of safety is value investment.

The definition is clear, but it is not easy to practice.

“Choose in your own circle of competence”: This first means that you have an unbiased and objective assessment of your own abilities. People are naturally narcissistic, and most people overestimate themselves; the circle of competence needs to be continuously expanded. A too small ability circle means that a lot of investment opportunities are missed; the expansion of the ability circle should not be too radical. People’s time is limited. Trying to understand a large number of tracks and projects may mean that the investor is not in these tracks. proficient.

“Quote at a price lower than the connotative value of the asset”: This means that you need to have the ability and a yardstick to measure the true value of the asset. More importantly, those invisible competitiveness that have not yet been reflected in the company’s balance sheet also need to be considered, such as those from network effects, switching costs, intangible assets (brands, franchise rights), and cost advantages. The moat factor.

“Leave a sufficient margin of safety”: The more margin of safety you leave, the less chance you will be able to strike. Going short after the judgment is correct is sometimes more painful than buying the wrong and losing money.

In the above process, Mr. Market will continue to confuse you. When asset prices are rising, he will encourage you not to sell. When assets are declining, he will persuade you to clear your positions and run away. Mr. Market is sometimes right and sometimes wrong. As long as you stare at him, he has the opportunity to influence you.

Every rule requires practice, knowing it is easy and doing it is hard.

Section Two

Does value investing really work in the currency circle?

You know, Buffett and his partner Charlie Munger have never liked crypto assets, and Buffett also called Bitcoin “rat poison.”

Even so, we believe that the concept of value investment is still valid in the currency circle.

Buffett may never buy a bitcoin in his life, just as he never invests in gold, because he believes that gold is “just a cube with a side of 20 meters”, it will not change after 10 years, and nothing will be produced. out. He doesn’t like gold, and naturally he doesn’t like the digital gold BTC .

But Buffett has invested in a company that produces gold, Barrick Gold, the world’s second largest gold mining company, because this company creates good cash flow.

I think if Buffett is 60 years younger, when he discovers that the crypto world also has a project with good cash flow and a wide moat, he will not be able to help it.

The four cornerstones of value investment can be applied in crypto investment with a little modification: buying a token means buying a project, a circle of ability, a margin of safety, and Mr. market.

How to understand these four concepts in the world of encryption, let us illustrate with a case.

1. Buying tokens is buying projects

All the value of project tokens is essentially because the project behind it provides value and can capture income. From the perspective of value investment, the crypto projects we want to invest in should have the following characteristics:

a. The tokens issued by the project can capture all or most of the economic value created by the project.

Example: There are some products that are very popular, have a large number of users, and are highly active, but most of the value of the project cannot be transferred to the tokens issued by it. Take the encrypted wallet as an example. The number of users, the number of transactions, and the number of assets under management are very large, but the token market value of the wallet project is very small. This is because most of the value that the wallet provides to its users cannot be captured and linked to by its tokens.

b. The problem to be solved by this project is of great value, the track is long and wide, and has a long life cycle

Example: Tornado cash, a coin mixer project , has a good concept and meets part of the demand (money laundering), but its demand scale is still quite limited compared to other tracks (there are not so many users who really have money laundering needs) , There is a clear ceiling of business scale. Correspondingly, financial services such as lending, trading, and derivatives are a healthier and longer-term track.

c. Excellent project management team

Example: Some projects started on a good track very early, but due to the comprehensive strength of the team, they were constantly surpassed in the later development. A typical example is the bugerswap, the earliest trading project on bsc.

2. Ability circle

As Charlie Munger said: “If I knew where I would die, then I would never go to that place for the rest of my life.”

Severe investment losses mostly occur in places where we don’t know enough but we think we know.

So how do you judge whether you “know or not”? Two standards can be referred to:

1. Our understanding of a track and a project surpasses at least other investors who have invested in this project by 90%;

2. When others talk about this project, there will be almost no information you don’t know, and there are few angles you haven’t thought about.

When the above standards are not met, it may indicate that you do not know enough about the project, and this is not where you should place a heavy bet.

3. Margin of safety

The premise of being able to give a margin of safety is that we already have an estimate of the “reasonable price” of the project. Based on this estimate, we will give another discount. This discount is the margin of safety you set aside for your investment.

Most of the current encryption projects are almost impossible to estimate accurately, especially public chains . Even for the Defi agreement with very transparent cash flow, it is difficult to use the DCF (discounted cash flow model) valuation method to value the project because it faces a large number of uncertain factors such as the duration of the project and the growth rate of project profits. The assumptions often lead to a “precision error.”

Therefore, the relative valuation method may be a more pragmatic method. We have adopted this method more in past research reports. If you are interested, you can read our past research reports.

Perhaps most of the time we cannot figure out the reasonable valuation of a project, but we can find those “visible” underestimated projects through the relative valuation method.

As Buffett said, when we see a fat man, even if we don’t know his specific weight, we know that this is a fat man.

4. Mr. Market

Regarding this, only need to chant on the basis of following the first three price investment principles: What Mr. Market is useful to us is the quotation in his pocket, not his wisdom; the market report is not the truth about the project, but It is the vote of everyone in the market today.

When we try to make crypto investments with the concept of value investing, before making a buying and selling decision, we will continue to ask 4 questions——

1. Is this project a good project on a good track? (Buying tokens is buying projects)

2. For this project, have I reached the standard of understanding? (Competence circle)

3. I bought at the current price, leaving a margin of safety? (boundary of safety)

4. Am I using the market or am I being used by the market? (Mr. Market)

Of these 4 questions, 1, 3 help us review our ignorance, and 2, 4 help us fight against the weaknesses of human nature.

Ignorance and humanity are the only two reasons why we lose big money in the market.

Section Three

Finally, how should value investing look at selling

My standard is to sell in the following two situations-

1. The reason for buying an asset is no longer valid. For example, the competitive landscape of the race track that was optimistic at the time has deteriorated rapidly, the project moat that was once thought is in fact only as deep as the calf, and there are serious problems with the team’s character and management level, and so on.

2. The price of the asset has risen too high, and its potential rate of return is too low. Compared with other assets, the potential rate of return is higher. Then sell the asset and exchange it for a more cost-effective asset. Investment is always constant calculation, measurement and comparison. Even if holding RMB cash is an investment, you can understand it as a demand bond (deposited in a currency fund) with an annual interest rate of about 2% .

Value investing is certainly not the only right way to invest in the crypto world.

Maybe someone can make sustained profits by relying on technical analysis, and there are always olfactory investors who can set sail in advance when the wind blows to catch up with the narrative wave of the market.

However, there is also cruel competition in the above fields, and the reflexivity of the market is constantly destroying the rules that have been fulfilled.

More importantly, is this really in your circle of competence?


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