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Sham Gad
Sham Gad

The Intelligent Art of [Value] Investing

June 06, 2007
I have lately been hearing the term "value investing," in so many investment strategies that I began to ask myself two fundamental questions:

1. What do all these people really mean when they say that they are value investing?

2. What makes a value investor?
3.  Do most investors realize that they are really engaged in some form of speculative activity?

Let's be clear from the start. Ben Graham was an investor. Warren Buffett is an investor. Mason Hawkins is an investor. The term value investing was given to their style simply to define what they do best: finding value--companies worth more than their current market price--investments.

In my opinion, the best definition of an investment was given by Ben Graham in Security Analysis:

"An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return . Operations not meeting these requirements are speculative."
So there it is. A simple, yet elegant definition of what investing ought to be. If you want to call it value investing, be prepared to explain what that really means. When Charlie Munger remarked "all intelligent investing is value investing," he knew exactly what he was saying. If you say you are a value investor, then without exception, you should be applying the three qualifications that Ben Graham laid down over seventy years ago. Each investment should be made only after a detailed assessment of the facts, a compelling valuation that provides a margin of safety, and a return that is better than other viable options adjusted for risk. I would be willing to wager that at least 75% of so called value investors don't come close to passing the test. You can forget about the majority of mutual funds with the name "Value" in them, as they are merely practicing the art of picking stocks with low price to earnings and price to book ratios.

Charlie Munger said it best when he remarked:

"Our investment style has been given a name - focus investing - which implies ten holdings, not one hundred or four hundred. The idea that it is hard to find good investments, so concentrate in a few, seems to me to be an obvious idea. But 98% of the investment world does not think this way. It's been good for us."

The number one key to a intelligent investing approach is discipline. Discipline is what prevents you from losing money. Preservation of capital is name of the game. I am glad I got a [relatively] early start in investing my own money, because when I look back at my approach, it wasn't truly the prudent approach outlined by Graham. It worked, but the great thing about this game is that if you stay disciplined you are going to learn a lot over time.

The key to remember is that a value investing does not exist in bull markets. Just about any approach during bull markets will make you money. As Seth Klarman aptly put it Bull markets "have of way of making everyone look like a genius." A true value investing based approach is designed for bear markets. A value investor's approach is one that can weather the storm during the bear markets and come out with a minimal loss of capital. A successful investing record should be measured in bear markets alone. Earning 90% in a year when the overall market is up 25% tells me zilch about your abilities as an investor. Just look at how many Internet funds were up over 100% per year during their heyday. Losing 10% when the market has tanked 25% on the other hand shows me that an intelligent and disciplined approach was used in making investment decisions.

As Warren Buffet said "Investing is simple, but not easy." There are only three types of stocks: undervalued, overvalued, and fairly valued. What determines the category is simply the price you pay. The worst business in the world can still be undervalued at the right price. So based on the price you pay, the business will either be overvalued, fairly valued, or undervalued. One simply must sell the first, ignore the second, and buy the third without any deviation in approach. This is intelligent investing.

Finally, people become more confusing when they start talking about value investing and growth investing as if they were too separate methods of operations.  All good investments have to grow and make money in order for the investor to generate returns.  Any investment deemed a value must have a catalyst that will unlock this value.  Usually these catalysts arise of some sort of management activity that will in some way make the company more profitable in the future.  The key to this process is time and most investors define an adequate period of time as the next earnings quarter.  As long this investor misguidance continues, the true intelligent investors should continue to excel above the rest.


About the author:

Sham Gad
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 2.8/5 (10 votes)


Armeetofo - 10 years ago    Report SPAM
good work, sham
Wildcat - 10 years ago    Report SPAM
Ben Graham went broke 3 times in the stock market.
Billytickets - 10 years ago    Report SPAM
I agree that many think they are "value investors" just like 80% of all surgeons think they are in the top 20% of all surgeons in America. My book Consume Consume and consume More Gives the investor 5 filters as well as a NUMERICAL formula to tell whether an investment is suitable. Predicting earnings on a company like Google is much harder than predicting a company like Hershey which has over 100 years of data. Buying a company with growing earnings priced"favorably" will do well
Armeetofo - 10 years ago    Report SPAM
the key is everyone might lose a couple times in the life time, if he moved on, learn the experiences from the past, and become a winner, he is real man!

if you fear to lose or you were a loser and do nothing further, what should i say?
Armeetofo - 10 years ago    Report SPAM

what you said about Ben Graham is true, i respect him a lot more, he is a geart guy! in contrast, warren is only a big winner and luky guy due to learn something from his teacher.
Zdlan - 10 years ago    Report SPAM
> There are only three types of stocks: undervalued, overvalued, and fairly valued.

It might be true in theory. In practice, for an investor,

lots of stocks belong to the fourth type: unknown.

Principle of "circle of competence" says: avoid those stocks. For one, a stock can be unknown, and for another investor, it can be "over", "fair" or "under" valued.

Do what you know.

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