In “Value Investing: Tools and Techniques for Intelligent Investment” (in my opinion, one of the best books ever written on the merits of value investing), James Montier outlines a list of 10 tenets that represent his investment philosophy. Here is a breakdown of the list (with a bit of my own commentary):
1. Value, Value, Value:
This is the basis of what we believe in as value investors. Markets are not efficient, and the stock prices we see on the ticker each and every day are often at a striking disconnect to the intrinsic value of the underlying business; in the words of Warren Buffett, “Price is what you pay, value is what you get.” Usually, this means buying the unloved, misunderstood, and the neglected. While it might not be as fun as chasing the hottest trends and stocks, it’s a great strategy for building long term wealth: By the traditional ratios for differentiating between growth and value (P/B, P/E, etc), the latter has consistently and decidedly been the better investment.
2. Be Contrarian:
Buying the unloved, misunderstood, and neglected means going against the crowd, a task much easier said than done: Many people take comfort with the herd, and choose to fail conventionally rather than to succeed unconventionally. Value investors must be able to step away from the noise, and be greedy when others are fearful.
3. Be Patient:
In my mind, this is an often overlooked attribute of many successful investors. Warren Buffett likes to say that you should imagine you have a punch card with 20 holes, and need to punch one out every time you make an investment decision. As he notes, you would make sure to do adequate due diligence in your investment decisions (and find those with long term merit via sustainable competitive advantages) if you followed this mental strategy. Yet most people continually seek action; they get caught up in the noise, and feel as if they must do something. The best example I can give for avoiding this desire is that from 1985-1988 (after his Cap Cities investment), Warren sat for three years twiddling his thumbs without making a single purchase. At that time, Berkshire only held seven securities that had a market value of over $25 million (of more than $1 billion invested, so at least 2.5% of the portfolio), suggesting that they were simply waiting for value to present itself; this should say a lot about the overemphasis on diversification and the lack of patience practiced by many investors in their personal portfolios.
4. Be Unconstrained:
As I’ve noted previously (here), this is one of the advantages that individual investors hold over many institutions. A great example is a stock that is removed from the S&P 500, and as a result is left beaten down by previous owners (index funds, for example) who have no other option but to close their positions. An unconstrained investor can search and take advantage of value opportunities regardless of the asset class, market capitalization, or any other characteristics that restricts specialized managers.
5. Don’t Forecast:
Let me say that one more time: Don’t forecast. As Ben Graham once said, “Forecasting security prices is not properly a part of security analysis.” Empirical evidence shows that analysts can’t do it (at least not effectively and consistently); there is a very good chance that you can’t either. By focusing on conservative measurements of value (this is certainly not through “tools” like WACC) and demanding a margin of safety, you can relieve yourself from the foolish task of deriving precise (and misleading) calculations of intrinsic value.
6. Cycles Matter:
I am much less versed on macroeconomics than Mr. Montier (who has an economics background), but believe that the global recession is sufficient evidence of why understanding things like credit cycles and how they work are advantageous to intelligent investors.
7. History Matters:
Kindleberger and Minsky have laid out the general framework for the timeline/process of bubbles: Displacement, Credit Creation, Euphoria, Financial Distress, and Revulsion. As Mr. Montier points out in the book, this pattern is directly applicable and has been consistently played out in history, from the South Sea Bubble of the 1700s to the credit/housing bubble we just witnessed. By studying the past, we can learn about and prepare for what the future may hold.
8. Be Skeptical:
This is where truly great investors are separated from the crowd. Bruce Berkowitz has noted that when he is pondering an investment, he tries to “kill the company:” “We spend a lot of time thinking about what could go wrong with a company – whether it’s a recession, stagflation, zooming interest rates or a dirty bomb going off. We try every which way to kill our best ideas. If we can’t kill it, maybe we’re on to something.” Next time you have an investment idea, try and kill it and see where that leads you to; you would be surprised what you can find when you stop accepting “conventional wisdom.”
9. Be Top-Down and Bottom-Up:
As Montier notes, “While stock selection is best approached from the bottom-up, ignoring the top-down can be extraordinarily expensive.” This goes along with number six, and is another area that I personally need to devote additional time to. As the current environment suggests, understanding things like inflation/deflation, the effects they have on asset classes and applicable forms of insurance against them is fundamental to building an effective investment strategy and portfolio.
10. Treat Your Clients Like You Would Yourself:
While this isn’t applicable to individual investors, it may be a great tool for protecting yourself from emotional decision making. If you were managing the retirement fund for your close friends and family, would you feel safe putting their savings in a name like Salesforce.com (CRM)? Do you truly understand the business and the opportunities, or are you simply following some talking head on CNBC? This mindset might stop you from speculating, and any strategy that forces you to stop and think before making any investment decision is an intelligent one.
1. Value, Value, Value:
This is the basis of what we believe in as value investors. Markets are not efficient, and the stock prices we see on the ticker each and every day are often at a striking disconnect to the intrinsic value of the underlying business; in the words of Warren Buffett, “Price is what you pay, value is what you get.” Usually, this means buying the unloved, misunderstood, and the neglected. While it might not be as fun as chasing the hottest trends and stocks, it’s a great strategy for building long term wealth: By the traditional ratios for differentiating between growth and value (P/B, P/E, etc), the latter has consistently and decidedly been the better investment.
2. Be Contrarian:
Buying the unloved, misunderstood, and neglected means going against the crowd, a task much easier said than done: Many people take comfort with the herd, and choose to fail conventionally rather than to succeed unconventionally. Value investors must be able to step away from the noise, and be greedy when others are fearful.
3. Be Patient:
In my mind, this is an often overlooked attribute of many successful investors. Warren Buffett likes to say that you should imagine you have a punch card with 20 holes, and need to punch one out every time you make an investment decision. As he notes, you would make sure to do adequate due diligence in your investment decisions (and find those with long term merit via sustainable competitive advantages) if you followed this mental strategy. Yet most people continually seek action; they get caught up in the noise, and feel as if they must do something. The best example I can give for avoiding this desire is that from 1985-1988 (after his Cap Cities investment), Warren sat for three years twiddling his thumbs without making a single purchase. At that time, Berkshire only held seven securities that had a market value of over $25 million (of more than $1 billion invested, so at least 2.5% of the portfolio), suggesting that they were simply waiting for value to present itself; this should say a lot about the overemphasis on diversification and the lack of patience practiced by many investors in their personal portfolios.
4. Be Unconstrained:
As I’ve noted previously (here), this is one of the advantages that individual investors hold over many institutions. A great example is a stock that is removed from the S&P 500, and as a result is left beaten down by previous owners (index funds, for example) who have no other option but to close their positions. An unconstrained investor can search and take advantage of value opportunities regardless of the asset class, market capitalization, or any other characteristics that restricts specialized managers.
5. Don’t Forecast:
Let me say that one more time: Don’t forecast. As Ben Graham once said, “Forecasting security prices is not properly a part of security analysis.” Empirical evidence shows that analysts can’t do it (at least not effectively and consistently); there is a very good chance that you can’t either. By focusing on conservative measurements of value (this is certainly not through “tools” like WACC) and demanding a margin of safety, you can relieve yourself from the foolish task of deriving precise (and misleading) calculations of intrinsic value.
6. Cycles Matter:
I am much less versed on macroeconomics than Mr. Montier (who has an economics background), but believe that the global recession is sufficient evidence of why understanding things like credit cycles and how they work are advantageous to intelligent investors.
7. History Matters:
Kindleberger and Minsky have laid out the general framework for the timeline/process of bubbles: Displacement, Credit Creation, Euphoria, Financial Distress, and Revulsion. As Mr. Montier points out in the book, this pattern is directly applicable and has been consistently played out in history, from the South Sea Bubble of the 1700s to the credit/housing bubble we just witnessed. By studying the past, we can learn about and prepare for what the future may hold.
8. Be Skeptical:
This is where truly great investors are separated from the crowd. Bruce Berkowitz has noted that when he is pondering an investment, he tries to “kill the company:” “We spend a lot of time thinking about what could go wrong with a company – whether it’s a recession, stagflation, zooming interest rates or a dirty bomb going off. We try every which way to kill our best ideas. If we can’t kill it, maybe we’re on to something.” Next time you have an investment idea, try and kill it and see where that leads you to; you would be surprised what you can find when you stop accepting “conventional wisdom.”
9. Be Top-Down and Bottom-Up:
As Montier notes, “While stock selection is best approached from the bottom-up, ignoring the top-down can be extraordinarily expensive.” This goes along with number six, and is another area that I personally need to devote additional time to. As the current environment suggests, understanding things like inflation/deflation, the effects they have on asset classes and applicable forms of insurance against them is fundamental to building an effective investment strategy and portfolio.
10. Treat Your Clients Like You Would Yourself:
While this isn’t applicable to individual investors, it may be a great tool for protecting yourself from emotional decision making. If you were managing the retirement fund for your close friends and family, would you feel safe putting their savings in a name like Salesforce.com (CRM)? Do you truly understand the business and the opportunities, or are you simply following some talking head on CNBC? This mindset might stop you from speculating, and any strategy that forces you to stop and think before making any investment decision is an intelligent one.
