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What Would Value Investing 101 Look Like?

February 27, 2012 | About:
Geoff Gannon

Geoff Gannon

414 followers
Someone who reads my articles asked me this question:

Hi Geoff,

Assuming someone had the temperament, interest and work ethic to be a good investor. What would you prescribe as a curriculum?

Which books, articles, shareholder letters, blogs, websites, etc. If you were going to have an extensive class on value investing, what would the materials list look like?

Thanks,

Ryan


Here is what I would make required reading:

· Warren Buffett’s Letter to Shareholders (1977-Present)

· Warren Buffett’s Letter to Partners (1959-1969)

· The Snowball: Warren Buffett and the Business of Life

· Buffett: The Making of An American Capitalist

· Poor Charlie’s Almanack

· Common Stocks and Uncommon Profits (by Phil Fisher)

· The Interpretation of Financial Statements (by Ben Graham)

· The Intelligent Investor (1949 Edition)

· Security Analysis (1940 Edition)

· Benjamin Graham on Investing

· Benjamin Graham: The Memoirs of the Dean of Wall Street

· One Up on Wall Street (by Peter Lynch)

· Beating the Street (by Peter Lynch)

· You Can Be a Stock Market Genius (by Joel Greenblatt)

· The Little Book That Beats the Market (by Joel Greenblatt)

· There’s Always Something to Do (about Peter Cundill)

· The Money Masters

· Money Masters of Our Time

· Hidden Champions of the Twenty-First Century

· Jim Collins Books (Built to Last, Good to Great, How the Mighty Fall, and Great by Choice)

· Distant Force (about Henry Singleton)

· Kuhn’s The Structure of Scientific Revolutions and The Essential Tension

Part of the class would require reading some material about extreme stock market conditions like:

· The Big Short

· Too Big to Fail

· This Time is Different

· When Genius Failed

· The Panic of 1907

This part of the class would revolve around contemporary sources. Students would read newspaper articles from the various crashes. They’d also read newspapers around the time of the various market bottoms. Historical case studies should be based on sources that were present and available to investors, CEOs, etc., at the time. So, if you’re studying an investment Ben Graham made in 1942 – you should be using The New York Times archives to find articles printed in 1942 and you should be getting your data from a Moody’s Manual from 1942.

This is critical.

And many people have never done it. Many investors have never gone back through old Moody’s Manuals, newspaper articles, etc. If you think you know enough about 1929 and yet you’ve never read something written in 1929 – you’re idea of knowing is too intellectual and external. Knowing is understanding what the paper looked like every morning to folks who were as blind to the future as you are now. You have to internalize what it feels like to be in the middle of all that.

Reading Kuhn’s books – The Structure of Scientific Revolutions and The Essential Tension – will help you understand why this is important. Why modern accounts of past investment beliefs are almost always wildly inaccurate attempts to act like people in the past shared the beliefs we have today. They didn’t. Beliefs change. In fact, the two cornerstone concepts of equity investing — that stocks are investments and that stocks tend to outperform other assets — were heretical beliefs when Ben Graham started his career. They are orthodoxy today.

The rest of the class would be limited to two other activities:

1. Historical examples of investments made by investors whose books, letters, etc., the class has read

2. Side-by-side comparisons of stocks with the names of the companies redacted

So, for example we would study:

· Warren Buffett’s investment in:

o GEICO

o Wells Fargo

o Coca-Cola

o Gillette

o Washington Post

o Arcata

o Disney

o American Express

o Sanborn Map

o Dempster Mills

o Commonwealth Trust

o Berkshire Hathaway

o Union Street Railway

· Ben Graham’s investment in:

o Northern Pipeline

o DuPont/GM (long/short)

o Missouri, Kansas, & Texas Railroad (old common stock while company was in bankruptcy)

· Joel Greenblatt’s investments presented in: “You Can Be a Stock Market Genius

· Peter Lynch’s investments presented in: “One Up on Wall Street” and Beating the Street

· Phil Fisher’s examples given in: “Common Stocks and Uncommon Profits

· Peter Cundill’s investments presented in: “There’s Always Something to Do

At least half the class time would be devoted to side-by-side comparisons of stocks with the company names redacted. Ben Graham did this all the time. Students wouldn’t be told ahead of time which kind of comparison they were seeing. Comparisons of Company A, Company B, etc., would include comparisons like:

· Microsoft at several different points in its history

· Present day comparison of Wal-Mart and Costco

· Present day comparison of all the major North American railroads

· Present day comparison of a high-quality huge company (like Procter & Gamble) and a high-quality tiny company (like United-Guardian)

· Comparison of present-day hated company (like Bank of America) and a historical Warren Buffett investment (like GEICO)

And so on…

Every single class would feature comparisons between unnamed stocks. Sometimes they would be “actionable ideas” like Wal-Mart vs. Costco. Sometimes they would be meant as eye-openers (for example, there are micro caps with the same ROEs, margins, consistency, etc., as blue chips). Other times they might be trickier – for example, comparing two stocks Warren Buffett could have bought back in the 1970s, 1980s, etc., only one of which he actually did buy.

When teaching historical examples, I would always include a present-day example. So, for instance, you would never just teach the fact that Warren Buffett bought net-nets for his partnership. You’d bring some modern day net-nets with you to class that day.

Finally, it would be too difficult to assign books and other research materials about specific companies to the whole class. But this is critical work. So, each student would be required to research one long-lived company (like Disney, Gillette, etc.) and present its entire history to the class explaining how the company was founded, where it faltered, what were the key economic drivers for the company early on, how it changed as it grew, who the different CEOs were and how they each ran the company, etc.

Disney is a good example. Most of the information you need is in Neal Gabler’s biography of Walt. But there are actually plenty of companies where it’s quite easy to do this work just using widely available sources. Examples include: Wal-Mart, Microsoft, Apple, Coca-Cola, etc.

I’d also let students choose a “tycoon” rather than a business. For example, a presentation on how Cornelius Vanderbilt made his fortune would be as interesting as any discussion of a company. By the way, there’s a great biography of Cornelius Vanderbilt by T.J. Stiles. Other good research candidates include John D. Rockefeller, Andrew Carnegie, etc.

Everyone would have to do a long-term solo research project. Value investing is mostly about doing original research alone.

And, of course, everyone would take a turn picking the present-day stock they like best and putting it up on the board as a blind stock valuation. The idea with a blind stock valuation is that you only answer questions you are asked. So, the students learn which questions are important to ask – and in what order – about a stock even when they don’t know the name. They learn to recognize unusual returns on equity, margins, asset turnover ratios, growth histories, etc., and get away from just accepting the conventional wisdom about a stock based on its name, industry, etc.

This is pattern recognition. And it’s the most important part of value investing aside from controlling your emotions.

So every class would start with someone putting their favorite actionable stock idea on the board along with its key characteristics. But no name. And then that student would have to answer any questions the class asked. (Except for questions where an honest answer would risk identifying the company). If for some reason the class wanted to know if the founder still controlled the company – they’d tell them. If the class wanted to know what year the company was founded – they’d tell them. If the class wanted to know the exact gross margin last quarter – and that wasn’t already on the board – they’d put it up there. And so on.

This way, everyone would get a chance of seeing what it takes to be totally knowledgeable and prepared about a single stock you picked yourself. And everyone would get many chances to experience what it’s like to investigate a potentially interesting investment starting from a point of total ignorance and moving towards understanding based on what questions you choose to ask.

That’s it.

I would focus on practical examples. I wouldn’t teach specific valuation techniques, ratios, accounting, etc. except insofar as they appear in the reading material and someone was confused by it. Once something technical like that became relevant to a specific stock example, we’d discuss it. But not before then.

It’s important not to detach theory from practice. That’s why I’d focus on reading books by investors who talk about their actual investments. And that’s why all the reading would be done at home and the class time would be focused on putting specific stocks up on the board.

The majority of class time would be spent on concrete examples.

I can’t stress that enough. New value investors love reading books on theory and technique. They spend too little time studying specific stocks. Out in the wild, you never encounter a P/E ratio in isolation. It’s always attached to a living, breathing stock.

The focus needs to be on actual examples that put things like P/E ratios in their place – as just one aspect of the whole.

Ask Geoff a Question about Teaching Value Investing

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About the author:

Geoff Gannon
Geoff Gannon


Rating: 3.9/5 (32 votes)

Comments

Cogito
Cogito premium member - 2 years ago
Geoff, thank you for these book recommendations!

I would like to ask you and the other readers about your opinion about more academic books. Do you think that there is a good effort-to-reward-payoff with respect to becoming a better value investor in reading academic books on valuation, like e.g. the ones by Damodaran?

And one more question: I've noticed that several of the gurus monitored by gurufocus are CFA chart-holders. Do you think that obtaining a CFA charter - or at least partly working through a CFA programme - is an effective way to improve one's private investment decisions?
jayb718
Jayb718 - 2 years ago
Great Post Geoff.
benethridge
Benethridge - 2 years ago
Good ideas and good books, but this doesn't sound like just 101 to me (and yes, I've read about half the books you show above including Intelligent Investor and Security Analysis). This sounds like 101, 202, 303, and maybe even 404.

Maybe we just have a difference in meaning of the term "101", but Janet Lowe's Value Investing Made Easy followed by The Intelligent Investor would easily take up two full semesters.

Ben
MJS27
MJS27 - 2 years ago


can anyone recommend any "work books" that go through examples like the side by side described above?

i've read most of the books - but would like more practice - obviously the simple answer is real world live analysis - but i like the idea of some side by side work w/ commentary provided as well.
jayb718
Jayb718 - 2 years ago
MSJ: I always thought the examples provided in Security Analysis did a great job of comparing two or more sets of financials.

turkishharem
Turkishharem - 2 years ago
Excellent post, Geoff. Looks like I have a list to take to the library for the next couple of months (or years).

Maulik1981
Maulik1981 - 2 years ago
Great article.

Discover several ways to build Competitive Advantages and an Economic Moat. The MOATS book is now on Amazon.com

Moats : The Competitive Advantages Of 70 Buffett And Munger Businesses

http://www.amazon.com/dp/1105422860

This may be the best business book that describes the competitive advantages of profitable businesses. MOATS describes the nature of 70 selected businesses purchased by Buffett and Munger for Berkshire Hathaway Inc. MOATS is a very useful resource for investors, managers, students of business. Since its subject matter has proven success, MOATS may become a useful practical text in businesses schools around the world. MOATS also looks at the sustainability of these competitive advantages in each of the 70 chapters.
Maulik1981
Maulik1981 - 2 years ago
I encourage the prospective readers to read the abridged version of the book. The free abridged version contains 5 chapters among of total of 70 chapters that is available here on this link;

http://www.scribd.com/doc/76907884/MOATS-abridged-1-5-70-chapters-a-preview

Listen to the MOATS book introduction audio mp3

http:// www.frips.com/ moats.mp3

Here is a link to an audio file of the American Express chapter:

http:// www.frips.com/ axp.mp3

Here is an audio file of Wells Fargo, WFC chapter from MOATS book:

http:// www.frips.com/ wfc.mp3

Audio file of JNJ, the Johnson and Johnson chapter from MOATS:

http:// www.frips.com/ jnj.mp3

Audio file of the "Costco" chapter in MOATS

http:// www.frips.com/ costco.mp3

Audio file of the MOATS chapter on Ben Bridge Jeweler [/url]

[url=http://breakdownthedoor.com/.i/fe28dOi8vbS52Ni5mYWNlYm9vay5jb20vbC5waHA_2FdT1odHRwJTNBJTJGJTJGd3d3LmZyaXBzLmNvbSUyRmJiai5tcDMmYW1wO2g9X0FRRVVmcXBq]http:// www.frips.com/ bbj.mp3
budlab
Budlab - 2 years ago


The MOATS book introduction audio mp3 file: http://www.frips.com/moats.mp3

audio file of Wells Fargo, WFC chapter from MOATS book: http://www.frips.com/wfc.mp3

audio file of the Johnson and Johnson chapter from MOATS: http://www.frips.com/jnj.mp3

audio file of the Costco chapter in MOATS http://www.frips.com/costco.mp3

audio file of the American Express chapter: http://www.frips.com/axp.mp3

The IBM Chapter from MOATS. Why did Buffett buy into a technology services

company after so many years? http://www.frips.com/ibm.mp3

Here is a 1 min : 32 sec audio file of Warren Buffett talking about an economic castle and its moat http://www.frips.com/wbmoat.mp3

onthefringe
Onthefringe - 2 years ago
"It’s important not to detach theory from practice."

As a student I would want to add the valuation and assessment of a local company. It can be large or small. It can be public or private. But it should be "off the radar," and the proper documentation and company management should both be accessible. And the project should take place over the duration of the entire program.

The focus would be on quality and really learning how the economics of a business tie into valuation rather than rushing to spit out a model based on loose assumptions.The point would be to take the time over the course of a program to learn how many different considerations can go into a valuation. And to have real management and staff of a real company provide checks and balances regarding the assumptions and limitations of valuation techniques.

For example, when assuming certain growth rates in DCF (I know it's not the preferred method here, bare with me), management can give insight into what it actually takes in real to achieve and maintain those rates for the next 5 years or so, let alone forever. Especially considering competitors are fighting for the same profit pools.

Or when looking to revalue assets on a balance sheet, to see how close to or detached from reality fair market or replacement value really are. Or get an idea of what it really takes to maintain margins in a competitive environment, and the potential effects of leverage. This should really help solidify the idea that investing in an equity is in fact investing in part ownership of a company.

It might also help to touch upon evaluating business using "mental models" (AKA Charlie Munger style) that don't require intricate spreadsheets or a lot of work to initially determine whether a potential investment looks promising.

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