Identify the intrinsic value of a company by measuring a company’s – quality of earnings, market growth, and management’s strategy.
Assess the margin of safety between the intrinsic value and the market value of the company.
Often, the magnitude of the spread between the intrinsic value and market value of a company (or the company’s perceived value) can mislead investors to believe that the greater the value gap (when the intrinsic value is greater than the market value), the stronger the investment candidate.
To avoid value traps, we must take into account whether there is a catalyst to fill the value gap.
Examples of catalysts
Eternal factors – deregulation of industries and / or reforms to accounting systems
Internal factors – changes in corporate governance and / or management strategy