One of the most common mistakes new value investors make is to assume that value investing is just buying cheap stocks a low prices.
Nothing could be further from the truth. While value investors do seek out cheap stocks at low prices, there's much more to it than this. Deep fundamental research is essential if you are trying to become a successful value investor. It is more about the how and the why than price alone.
No investor is more aware of this than Seth Klarman (Trades, Portfolio). Over the years, Klarman has stated many times the importance of research in value investing.
Research and value investing
"Do not invest in companies that you don't understand. The changes in technology are often hard to keep pace with. The net assets of commercial banks and property and casualty companies are often difficult to analyze."
The above quote is taken from an article published in the Superinvestor Digest at the beginning of September 2006. The article pulls together a selection of quotes from a lecture given by Klarman to Columbia Business School close to the publication date. For added background, the authors also included some quotes from his now famous book, "Margin of Safety," and comments from other writings and lectures.
The article is a collection of Seth Klarman (Trades, Portfolio)'s best investment advice.
"While value investors focus on intrinsic value and margin of safety. Speculators are obsessed with predicting and guessing the direction of prices."
Some of the quotes in the article, like the one above, are well known. Others, however, are more bespoke and informative. For example:
"Value investors pay attention to financial reality in making their investment decisions. Investing is serious business, not entertainment."
And:
"Understand the difference between an investment and a collectible. An investment is one, which is able or will eventually be able to produce cash flow."
The above quote is an interesting take on the argument between investment and speculation. Trying to distinguish between these two investment styles is often tricky, and there is a grey area between the two here. However, Klarman seemed to sum up the argument succinctly.
He went on to state the importance of continual learning for value investors. It is essential for each investor to learn from their mistakes and build their investment process -- you can steal investment ideas but unless you know why the stock is undervalued and understand the opportunity, getting into the position is a mistake.
"Value investors are students of the game; they learn from every pitch, those at which they swing and those they let pass by. They are not influenced by the way others are performing: they are motivated only by their own results. Klarman advises value investors to cultivate 'infinite patience.'"
Klarman went on to say that it is essential for the investor not to be influenced by the market's movements. If you know that the security is a bargain when you purchase it, you can act rationally when the rest of the market is irrational.
"Security prices sometimes fluctuate, not based on any apparent changes in reality, but on changes in investor perception. When a price of a stock declines with no apparent reason. most investors become concerned. They worry that there is Information out there, which they are not privy to, 'Heck, I am going through this now with a position that is thinly traded, and sometimes I think I am the only purchaser out there.' The investor begins to second guess him or herself. It is easy to panic and just sell. 'Yet, if the security were truly a bargain when it was purchased, the rational course of action would be to take advantage of this even better bargain and buy more,' wrote Klarman."
Another take on the above quote:
"Think for yourself and don't let the market direct you."
And finally, Klarman's advice on sticking with what you know and only swinging for the most apparent pitches:
"For a value investor, a pitch must not only be in the strike zone, it must be in his 'sweet spot.' 'Above all, Investors must always avoid swinging at bad pitches,' said Klarman. Facing complex situations, investors could demand a greater discount than usual. 'Probably let more pitches go by.'"
Disclosure: The author owns no share mentioned.
