Lately I have headed back to re-read "Security Analysis" by Ben Graham, and it has proven to be a great refresher on the importance of focusing on value as opposed to price. Many of us are familiar with Graham's teachings, the foundations that he laid down on value investing and the success that most of his followers have had over the years. Most of us are familiar with his investing style, which was biased by the financial crisis.
While many of us believe that his investing style was guided only by quantitative factors, which he dwelled upon in both "Security Analysis" and "The Intelligent Investor," it is clear that he was very aware of the importance of the qualitative aspects of securities as well. The reason is well explained in "Security Analysis":
The untrained buyer fares best by purchasing goods of the highest reputation, even though he may pay a comparatively high price. But, needless to say, this is not a rule to guide the expert merchandise buyer, for he is expected to judge quality by examination and not solely by reputation, and at times he may even sacrifice definite degrees of quality if that which he obtains is adequate for his purpose and attractive in price. This distinction applies as well to the purchase of securities as to buying paints or watches. It results in principles of quite opposite character, the one suitable for the untrained investor, the other useful only to the analyst.
1. Principle for the untrained security buyer: Do not put money in a low-grade enterprise on any terms.
2. Principle for the securities analyst: Nearly every issue might conceivable be cheap in one price range and dear in another.
There are a lot of lessons here. The first one is the explanation of why many people overpay for securities, which is that they stick to the reputation of a company without further examination. However, the trained security analyst has among her duties the task of overcoming the fear of standing by herself, sometimes in obscure sectors, before the market realizes the real value and drives the price up (or down).
Graham makes it clear that only experts are able to make the trade-off between quality and reputation for return. This is best explained with the second tenet: Any given issue might prove to be cheap or expensive. However, the most important differentiator between the experts and untrained buyers is that experts are able to answer the question: Cheap or expensive, relative to what? The answer is that a purchase made through the combination of both a good estimate of intrinsic value and a margin of safety is the only way to ensure that the trade-off between quality and return turns out to be favorable for the investor.
What do you think?
