The core of value investing lies in assessing a company’s intrinsic value—the present value of all its future free cash flows—and then comparing it to the current market price. An investment is worthwhile only when the market price is significantly lower than the intrinsic value (i.e., a “margin of safety” exists). Value investing posits that a company’s long-term value is ultimately determined by its ability to generate sustained cash flows, not short-term stock price fluctuations or market sentiment.
The evaluation process follows the principle of “qualitative analysis takes precedence over quantitative analysis”: first, determine if the company has the foundation for long-term survival and profitability (industry dynamics, competitive moats, management team); then quantify the intrinsic value using financial data; and finally, use a margin of safety to hedge against prediction errors. Below is a comprehensive, integrated framework with practical U.S. and Chinese market examples, balancing theoretical rigor and operational feasibility.
I. Step 1: Qualitative Analysis – Determine If the Company “Worths Valuing” (Prerequisite for Value Investing)
Qualitative analysis is the core of screening targets, avoiding wasting time on companies with no long-term value (e.g., highly cyclical firms, those without competitive barriers, or unreliable management). Focus on three key dimensions:
1. Industry Structure: Is the Track “Long-Term Growth-Oriented” and “Orderly Competitive”?
- Core Evaluation Criteria:
- Industry Life Cycle: Prioritize industries in the “late growth → mature stage” (e.g., cloud computing in the U.S., high-end liquor in China), avoiding declining industries (e.g., traditional gasoline-powered vehicles) or overcrowded red oceans (e.g., ordinary building materials in China).
- Industry Barriers: Are there policy barriers (e.g., U.S. pharmaceutical approvals, Chinese financial licenses), technological barriers (e.g., chip patents), or scale barriers (e.g., Amazon’s logistics network)? Higher barriers lead to milder competition and more stable profitability.
- Supply-Demand Dynamics: Is long-term demand rigid (e.g., healthcare, consumer goods)? Avoid industries dependent on short-term policy stimulus (e.g., China’s real estate upstream/downstream) or rapid technological iteration (e.g., consumer electronics hardware).
- U.S. & Chinese Market Examples:
- U.S. Market: Amazon (AWS Cloud Computing) is transitioning from late growth to maturity. The cloud computing industry has rigid demand (enterprise digital transformation), and Amazon holds a 32% global market share with stable competitive dynamics, thanks to economies of scale and technological barriers.
- Chinese Market: Kweichow Moutai (high-end liquor) is in the mature stage. Industry demand is less affected by economic cycles (rigid for gifting and personal consumption), and Moutai’s brand moat (historical heritage, scarce production capacity) has no substitutes, forming a monopolistic competitive structure.
2. Company’s Competitive Moat: Does It Have “Sustainable Competitive Advantages”? (Core of Long-Term Profitability)
A competitive moat is the key to a company’s ability to maintain high gross profit margins and ROE (Return on Equity) over the long term, serving as the most critical “safety cushion” in value investing. Common moat types and examples:
| Moat Type | Core Logic | U.S. Market Examples | Chinese Market Examples |
|---|---|---|---|
| Brand Barrier | Consumers are willing to pay a premium for the brand and make repeat purchases | Coca-Cola (global brand recognition) | Kweichow Moutai (top high-end liquor brand) |
| Technological/Patent Barrier | Core technologies are hard to replicate, protected by patents | Apple (iOS system + chip patents) | CATL (power battery patent portfolio) |
| Scale/Cost Barrier | Larger scale leads to lower unit costs, which competitors cannot match | Walmart (global supply chain cost advantage) | Gree Electric (air conditioner production scale advantage) |
| Network Effect | More users increase product value, forming a monopoly | Meta (social network user stickiness) | WeChat (monopolistic social ecosystem in China) |
| Policy/License Barrier | Government authorization restricts new entrants | American Express (payment license) | Ping An Insurance Group (comprehensive financial license) |
- Evaluation Method: Check if the company’s gross profit margin and ROE have consistently outperformed industry averages over the past 10 years (e.g., average ROE of S&P 500 companies is ~15%, while CSI 300 is ~12%) with low volatility (e.g., Moutai’s ROE has remained above 25% for a decade).
3. Management Capability and Integrity: Is It “Shareholder-Focused”?
Value investing is essentially “investing in management.” Even with a strong industry and moat, poor management decisions (e.g., blind expansion, financial fraud) can destroy company value.
- Core Evaluation Criteria:
- Capital Allocation Capability: Does the company use profits to “enhance shareholder returns” (e.g., dividends, share repurchases) rather than blind diversification (e.g., Vanke’s early cross-border ventures into car manufacturing and pig farming, which distracted from its core business)?
- Integrity and Transparency: Are financial statements authentic (e.g., the collapse of Enron in the U.S. and Luckin Coffee in China due to financial fraud led to delisting)? Does management hold long-term company shares (interest alignment)?
- Long-Term Orientation: Does the company prioritize R&D and brand building (e.g., Amazon’s continuous investment in AWS R&D, Moutai’s ongoing brand image maintenance) over short-term performance?
II. Step 2: Quantitative Analysis – Calculate the Company’s “Intrinsic Value” (Core Valuation Methods)
Quantitative analysis is the “quantitative implementation” after qualitative screening, focusing on predicting future cash flows and discounting them to the present. Value investing relies on “cross-validation of multiple methods” rather than a single indicator to avoid model errors.
1. Foundation: Interpret Core Financial Data (Screen for Healthy Companies)
First, assess the company’s “financial quality” using three core indicators before valuation:
- ROE (Return on Equity): Measures the company’s ability to “generate profits with shareholders’ capital.” Value investors prefer companies with “long-term ROE ≥15% and stability” (e.g., Microsoft’s ROE has exceeded 30% for a decade, while Hengrui Medicine’s ROE has remained above 20% in China).
- Free Cash Flow (FCF): The remaining cash after deducting capital expenditures from operating cash flow (funds freely distributable to shareholders), which is the core source of intrinsic value. Avoid companies with “profits but no free cash flow” (e.g., some capital-intensive industries where earnings are reinvested in equipment upgrades, leaving no funds for dividends).
- Asset-Liability Ratio and Solvency: Avoid highly leveraged companies (e.g., China’s real estate industry with asset-liability ratios ≥80%). Focus on “interest-bearing debt/net assets” (e.g., Apple’s interest-bearing debt ratio is only 10%, with strong financial safety) and “monetary funds covering short-term interest-bearing debt” (e.g., Moutai’s monetary funds can cover short-term liabilities five times over).
2. Core Valuation Methods: Three Mainstream Models (From “Absolute Valuation” to “Relative Valuation”)
(1) Absolute Valuation: Discounted Cash Flow (DCF) Model – The “Ultimate Method” of Value Investing
The core logic of the DCF model is: “A dollar today is worth more than a dollar tomorrow.” The intrinsic value is the sum of the present value of the company’s free cash flows over the next 10 years, plus the present value of the “terminal value” (perpetual operating value) after 10 years.
- Simplified Formula:Intrinsic Value (IV) = Present Value of Free Cash Flows (Next 10 Years) + Present Value of Terminal Value
- Key Parameter Calculations (Practical Focus):
- Predict Future Free Cash Flows:
- Assume the company maintains the industry average growth rate for the first 5 years (e.g., 20% for the U.S. cloud computing industry, 10% for China’s high-end liquor industry), then gradually reduces to the “risk-free rate level” (e.g., 4.5% for U.S. 10-year Treasury bonds, 2.5% for Chinese 10-year Treasury bonds) to avoid over-optimistic forecasts.
- Example: Suppose a U.S. tech company has current FCF of $1 billion, with 20% growth over the next 5 years and 5% growth for the subsequent 5 years. The total 10-year FCF is approximately $20 billion.
- Determine the Discount Rate:
- Discount Rate = Risk-Free Rate + Risk Premium (Industry Risk + Company-Specific Risk)
- U.S. Market: Risk-free rate (10-year U.S. Treasury yield) ≈4.5%, tech industry risk premium ≈6%, so discount rate ≈10.5%;
- Chinese Market: Risk-free rate (10-year Chinese Treasury yield) ≈2.5%, consumer industry risk premium ≈5%, so discount rate ≈7.5%.
- Calculate Terminal Value (Perpetual Value):
- Terminal Value = FCF in Year 10 × (1 + Perpetual Growth Rate) / (Discount Rate – Perpetual Growth Rate)
- The perpetual growth rate is usually set “below the risk-free rate” (e.g., 2%-3%) to avoid exceeding economic growth.
- Predict Future Free Cash Flows:
- Pros & Cons:
- Pros: Most aligned with the essence of intrinsic value, unaffected by market sentiment;
- Cons: High subjectivity in parameter forecasts (cash flows, growth rates, discount rates), requiring adjustments based on industry common sense (e.g., conservative growth forecasts for cyclical industries).
(2) Relative Valuation: Benchmark Against Industry Averages to Quickly Assess Valuation Levels
Relative valuation uses “valuation levels of comparable companies in the market” as a reference, suitable for companies where DCF parameters are difficult to predict (e.g., growth-stage companies). The core is matching “comparable companies + key indicators.”
| Valuation Indicator | Formula | Applicable Industries | U.S. Market Examples (Reasonable Range) | Chinese Market Examples (Reasonable Range) |
|---|---|---|---|---|
| P/E-TTM (Price-to-Earnings Ratio) | Stock Price ÷ Net Profit (Past 12 Months) | Mature companies with stable profits (consumer goods, utilities) | Coca-Cola (20-25x), Microsoft (30-35x) | Kweichow Moutai (25-30x), Yili Industrial Group (15-20x) |
| P/B (Price-to-Book Ratio) | Stock Price ÷ Book Value per Share | Finance, capital-intensive, cyclical industries (volatile profits) | Bank of America (0.8-1.2x), Chevron (1.5-2x) | Ping An Insurance Group (0.8-1.0x), Vanke (1.0-1.5x, during normal industry conditions) |
| P/S (Price-to-Sales Ratio) | Stock Price ÷ Operating Revenue | Growth-stage companies (unprofitable or unstable profits) | Amazon (2-3x, AWS business), Tesla (8-10x) | ByteDance (unlisted, ~6-8x P/S), CATL (5-7x) |
| EV/EBITDA (Enterprise Value-to-EBITDA) | Enterprise Value ÷ Earnings Before Interest, Taxes, Depreciation, and Amortization | Capital-intensive, highly leveraged companies (eliminates the impact of financial leverage) | Boeing (10-12x), General Motors (6-8x) | China State Construction Engineering (4-6x), Conch Cement (5-7x) |
- Key Usage Notes:
- Comparable companies must have “similar businesses and scale” (e.g., compare Moutai to Wuliangye, not to budget liquor brands);
- Avoid “cross-industry benchmarking” (e.g., comparing P/E ratios of tech stocks to banks);
- Combine “valuation + growth” (PEG Ratio): PEG = P/E ÷ 3-Year CAGR (Compound Annual Growth Rate), with a reasonable range of 0.8-1.2 (e.g., Microsoft’s P/E of 30x and 15% growth gives a PEG of 2, indicating overvaluation; Moutai’s P/E of 25x and 10% growth gives a PEG of 2.5, also overvalued).
(3) Asset-Based Valuation: Liquidation Value/Replacement Cost (Suitable for “Cigar Butt Stocks” or Capital-Intensive Companies)
Asset-based valuation calculates the “actual value of the company’s assets,” suitable for companies with poor core business performance but high-quality assets (e.g., distressed industrial enterprises, real estate developers with abundant land reserves).
- Liquidation Value: The remaining value after selling all assets (cash, inventory, fixed assets, equity investments) and repaying debts if the company goes bankrupt (e.g., Vanke’s current market capitalization is RMB 70.2 billion, with equity investments in GLP and ManWah Cloud worth ~RMB 60 billion, and inventory (land + properties) with a book value of ~RMB 900 billion. If liquidated at a 50% discount, the remaining value after debt repayment may exceed the current market capitalization);
- Replacement Cost: The cost to rebuild an identical company (e.g., a factory’s equipment + land + technology has a replacement cost of $1 billion, while its current market capitalization is $800 million, indicating a margin of safety);
- Note: Asset-based valuation requires deducting “intangible asset impairment” (e.g., goodwill, brands) and “inventory write-downs” (e.g., inventory depreciation in the real estate industry) to avoid overestimating actual asset value.
III. Step 3: Margin of Safety – The “Risk Hedge Tool” of Value Investing
Even with correct qualitative and quantitative analysis, predictions may contain errors (e.g., industry policy changes, management mistakes). The margin of safety is the core to avoiding losses.
- Definition: Purchase Price ≤ Intrinsic Value × (1 – Margin of Safety Rate);
- Reasonable Margin of Safety Rates:
- Mature companies (e.g., Coca-Cola, Moutai): 20%-30% (high certainty, moderate margin of safety);
- Growth-stage companies (e.g., Amazon, CATL): 30%-50% (volatile growth, higher margin of safety required);
- Turnaround companies (e.g., Vanke, American Airlines): ≥50% (high risk, only invest when extremely undervalued);
- Example: If Vanke’s intrinsic value is calculated at RMB 10 via the DCF model, a 50% margin of safety means the purchase price should be ≤RMB 5 (current price: RMB 5.21, close but not yet meeting the margin of safety; wait for further declines or intrinsic value improvements).
IV. Step 4: Dynamic Tracking and Adjustment – Value Investing Is Not “Buy and Hold Forever”
Intrinsic value is “dynamically changing” and requires regular updates (e.g., after quarterly earnings releases):
- Track Qualitative Factors: Has the industry structure changed (e.g., new competitors in China’s liquor industry)? Has the moat weakened (e.g., Apple’s technical patents breached)? Has management changed?
- Adjust Quantitative Parameters: Revise FCF and growth forecasts based on the latest financial reports (e.g., lower future cash flow forecasts if a company’s growth rate is below expectations);
- Recalculate Intrinsic Value: If intrinsic value falls (e.g., industry recession), lower the purchase price accordingly; if intrinsic value rises (e.g., exceeding earnings expectations), moderately increase the purchase price after applying the margin of safety.
V. Common Misconceptions: Avoid “Pseudo-Value Investing”
- Over-Reliance on Financial Data: Ignoring industry dynamics and moats, buying solely because of “low P/E or P/B” (e.g., some ST stocks in China with seemingly low P/E but consecutive losses and no intrinsic value);
- Over-Optimistic Forecasts: Treating short-term high growth as a long-term trend (e.g., forecasting a 30% 10-year growth rate for a new energy company with 50% short-term growth, leading to overestimated intrinsic value);
- Neglecting the Importance of Discount Rates: Excessively high or low discount rates can significantly distort intrinsic value (e.g., a 2% reduction in the U.S. market discount rate from 10% to 8% may increase intrinsic value by over 30%);
- Confusing “Value Investing” with “Long-Term Holding”: Long-term holding is a result, not a goal. If a company’s intrinsic value continues to decline (e.g., industry recession), sell decisively (e.g., Nokia in the early 2000s, traditional Chinese mobile phone manufacturers).
Summary: Core Logic of Value Investing Evaluation
- First, screen for companies with “competitive moats, stable industry structures, and reliable management” through qualitative analysis;
- Calculate absolute intrinsic value using the DCF model and cross-validate with relative valuation;
- Reserve a sufficient margin of safety to hedge against prediction errors;
- Conduct dynamic tracking and adjust intrinsic value judgments based on industry and company changes.
For novice investors, there’s no need to master the DCF model immediately. Start with “relative valuation + qualitative analysis” (e.g., screening consumer stocks with consistent ROE above 15% and P/E below industry averages), gradually accumulate industry knowledge and financial analysis skills, then transition to more complex absolute valuation. The core valuation logic is consistent across U.S. and Chinese markets; differences lie in adjusting parameters such as risk-free rates, industry growth rates, and risk premiums (e.g., higher overall valuations in the U.S. require a higher margin of safety, while undervaluation in some Chinese industries allows for a moderate reduction).
