Value investing
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Value investing is an investment paradigm that derives from the ideas on investment and speculation that Ben Graham & David Dodd began teaching at Columbia Business School in 1928 and subsequently developed in their 1934 text Security Analysis. Although value investing has taken many forms since its inception, it generally involves buying securities whose shares appear underpriced by some form(s) of fundamental analysis.[1] As examples, such securities may be stock in public companies that trade at discounts to book value or tangible book value, have high dividend yields, have low price-to-earning multiples or have low price-to-book ratios.
High profile proponents of value investing, including Berkshire Hathaway chairman Warren Buffett, have argued that the essence of value investing is buying stocks at less than their intrinsic value.[2] The discount of the market price to the intrinsic value is what Benjamin Graham called the "margin of safety". The intrinsic value is the discounted value of all future distributions.
However, the future distributions and the appropriate discount rate can only be assumptions. Warren Buffett has taken the value investing concept even further as his thinking has evolved to where for the last 25 years or so his focus has been on "finding an outstanding company at a sensible price" rather than generic companies at a bargain price.
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[edit] History
[edit] Benjamin Graham
Value investing was established by Benjamin Graham and David Dodd, both professors at Columbia Business School and teachers of many famous investors. In Graham's book The Intelligent Investor, he advocated the important concept of margin of safety — first introduced in Security Analysis, a 1934 book he coauthored with David Dodd — which calls for a cautious approach to investing. In terms of picking stocks, he recommended defensive investment in stocks trading below their tangible book value as a safeguard to adverse future developments often encountered in the stock market.
[edit] Further evolution
However, the concept of value (as well as "book value") has evolved significantly since the 1970s. Book value is most useful in industries where most assets are tangible. Intangible assets such as patents, software, brands, or goodwill are difficult to quantify, and may not survive the break-up of a company. When an industry is going through fast technological advancements, the value of its assets is not easily estimated. Sometimes, the production power of an asset can be significantly reduced due to competitive disruptive innovation and therefore its value can suffer permanent impairment. One good example of decreasing asset value is a personal computer. An example of where book value does not mean much is the service and retail sectors. One modern model of calculating value is the discounted cash flow model (DCF). The value of an asset is the sum of its future cash flows, discounted back to the present.
[edit] Value investing performance
[edit] Performance, value strategies
Value investing has proven to be a successful investment strategy. There are several ways to evaluate its success. One way is to examine the performance of simple value strategies, such as buying low PE ratio stocks, low price-to-cash-flow ratio stocks, or low price-to-book ratio stocks. Numerous academics have published studies investigating the effects of buying value stocks. These studies have consistently found that value stocks outperform growth stocks and the market as a whole.[3][4][5]
[edit] Performance, value investors
Another way to examine the performance of value investing strategies is to examine the investing performance of well-known value investors. Simply examining the performance of the best known value investors would not be instructive, because investors do not become well known unless they are successful. This introduces a selection bias. A better way to investigate the performance of a group of value investors was suggested by Warren Buffett, in his May 17, 1984 speech that was published as The Superinvestors of Graham-and-Doddsville. In this speech, Buffett examined the performance of those investors who worked at Graham-Newman Corporation and were thus most influenced by Benjamin Graham. Buffett's conclusion is identical to that of the academic research on simple value investing strategies--value investing is, on average, successful in the long run.
During about a 25-year period (1965-90), published research and articles in leading journals of the value ilk were few. Warren Buffett once commented, "You couldn't advance in a finance department in this country unless you taught that the world was flat."[6]
[edit] Well known value investors
Benjamin Graham is regarded by many to be the father of value investing. Along with David Dodd, he wrote Security Analysis, first published in 1934. The most lasting contribution of this book to the field of security analysis was to emphasize the quantifiable aspects of security analysis (such as the evaluations of earnings and book value) while minimizing the importance of more qualitative factors such as the quality of a company's management. Graham later wrote The Intelligent Investor, a book that brought value investing to individual investors. Aside from Buffett, many of Graham's other students, such as William J. Ruane, Irving Kahn and Charles Brandes have gone on to become successful investors in their own right.
Graham's most famous student, however, is Warren Buffett, who ran successful investing partnerships before closing them in 1969 to focus on running Berkshire Hathaway. Charlie Munger joined Buffett at Berkshire Hathaway in the 1970s and has since worked as Vice Chairman of the company. Buffett has credited Munger with encouraging him to focus on long-term sustainable growth rather than on simply the valuation of current cash flows or assets.[7] Columbia Business School has played a significant role in shaping the principles of the Value Investor, with Professors and students making their mark on history and on each other. Ben Graham’s book, The Intelligent Investor, was Warren Buffett’s bible and he referred to it as "the greatest book on investing ever written.” A young Warren Buffett studied under Prof. Ben Graham, took his course and worked for his small investment firm, Graham Newman, from 1954 to 1956. Twenty years after Ben Graham, Prof. Roger Murray arrived and taught value investing to a young student named Mario Gabelli. About a decade or so later, Prof. Bruce Greenwald arrived and produced his own protégés, including Mr. Paul Sonkin - just as Ben Graham had Mr. Buffett as a protégé, and Roger Murray had Mr. Gabelli.
Seth Klarman, the founder and president of The Baupost Group, a Boston-based private investment partnership, authored Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which since has become a value investing classic. Now out of print, Margin of Safety has sold on Amazon for $1,200 and eBay for $2,000.[8] Another famous value investor is John Templeton. He first achieved investing success by buying shares of a number of companies in the aftermath of the stock market crash of 1929.
Martin J. Whitman is another well-regarded value investor. His approach is called safe-and-cheap, which was hitherto referred to as financial-integrity approach. Martin Whitman focuses on acquiring common shares of companies with extremely strong financial position at a price reflecting meaningful discount to the estimated NAV of the company concerned. Martin Whitman believes it is ill-advised for investors to pay much attention to the trend of macro-factors (like employment, movement of interest rate, GDP, etc.) not so much because they are not important as because attempts to predict their movement are almost always futile. Martin Whitman's letters to shareholders of his Third Avenue Value Fund (TAVF) are considered valuable resources "for investors to pirate good ideas" by another famous investor Joel Greenblatt in his book on special-situation investment "You Can Be a Stock Market Genius" (ISBN 0-684-84007-3, pp 247)
Joel Greenblatt achieved annual returns at the hedge fund Gotham Capital of over 50% per year for 10 years from 1985 to 1995 before closing the fund and returning his investors' money. He is known for investing in special situations such as spin-offs, mergers, and divestitures.
Charles de Vaulx and Jean-Marie Eveillard are well known global value managers. For a time, these two were paired up at the First Eagle Funds, compiling an enviable track record of risk-adjusted outperformance. For example, Morningstar designated them the 2001 "International Stock Manager of the Year" and de Vaulx earned second place from Morningstar for 2006. Eveillard is known for his Bloomberg appearnances where he insists that securities investors never use margin or leverage. The point made is that margin should be considered the anathema of value investing, since a negative price move could prematurely force a sale. In contrast, a value investor must be able and willing to be patient for the rest of the market to recognize and correct whatever pricing issue created the momentary value. Eveillard correctly labels the use of margin or leverage as speculation, the opposite of value investing.
[edit] Criticism
An issue with buying shares in a bear market is that despite appearing undervalued at one time, prices can still drop along with the market.[9]
[edit] Value investing books and resources
- Security Analysis, editions 1934,[10] 1940[11], 1951[12] and 1962[13] and 1988 [14] and 2008 [15] ISBN 978-0-07-159253-6
- The Theory of Investment Value (1938), by John Burr Williams. ISBN 0-87034-126-X
- The Intelligent Investor (1949), by Benjamin Graham. ISBN 0-06-055566-1
- You Can Be a Stock Market Genius (1997), by Joel Greenblatt. ISBN 0-684-84007-3.
- Contrarian Investment Strategies: The Next Generation (1998), by David Dreman. ISBN 0-684-81350-5.
- The Essays of Warren Buffett (2001), edited by Lawrence A. Cunningham. ISBN 0-9664461-1-9.
- The Little Book That Beats the Market (2006), by Joel Greenblatt. ISBN 0-471-73306-7.
- The Little Book of Value Investing (2006), by Chris Browne. ISBN 0-470-05589-8.
- Value Investor Insight (www.valueinvestorinsight.com)
- Rule #1 (2006), by Phil Town. ISBN 0-307-33613-1.
- "The Four Filters Invention of Warren Buffett and Charlie Munger: Abridged Edition"
[edit] See also
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[edit] Value Investors at Wikiquote
[edit] References
- ^ Graham, Benjamin (1934). Security Analysis New York: McGraw Hill Book Co., 4. ISBN 0-07-144820-9.
- ^ Graham (1949). The Intelligent Investor New York: Collins, Ch.20. ISBN 0-06-055566-1.
- ^ The Cross-Section of Expected Stock Returns, by Fama & French, 1992, Journal of Finance
- ^ Firm Size, Book-to-Market Ratio, and Security Returns: A Holdout Sample of Financial Firms, by Lyon & Barber, 1997, Journal of Finance
- ^ Overreaction, Underreaction, and the Low-P/E Effect, by Dreman & Berry, 1995, Financial Analysts Journal
- ^ Joseph Nocera, The Heresy That Made Them Rich, The New York Times, October 29, 2005
- ^ Warren Buffett's 1989 letter to Berkshire Hathaway shareholders
- ^ The $700 Used Book. (2006, Aug. 7). BusinessWeek, Personal Finance section. Accessed 11-11-2008.
- ^ When Value Investing Doesn't Work
- ^ Graham and Dodd. 1934. Security Analysis: Principles and Technique, 1E. New York and London: McGraw-Hill Book Company, Inc.
- ^ Graham and Dodd. 1940. Security Analysis: Principles and Technique, 2E. New York and London: McGraw-Hill Book Company, Inc.
- ^ Graham et al. 1951. Security Analysis: Principles and Technique, 3E. New York: McGraw Hill Book Company, Inc.
- ^ Graham et al. 1962. Security Analysis: Principles and Technique, 4E. New York: McGraw-Hill Book Company, Inc.
- ^ Graham and Dodd. 1988. Security Analysis: Principles and Technique, 5E. McGraw-Hill Professional
- ^ Graham and Dodd. 2008. Security Analysis: Principles and Technique, 6E. McGraw-Hill Professional
