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Rupert Hargreaves
Rupert Hargreaves
Articles (740)  | Author's Website |

Re-Learning Lessons From Buffett's Best Essay

The Superinvestors of Graham and Doddsville never gets old

December 05, 2018 | About:

It is fair to say that over the past 12 months the market environment has changed significantly. Over the first six months of 2018, it looks as if the market was swept up in a bout of euphoria following the tax cuts at the end of 2017.

But, as quantitative tightening has gotten underway around the world, the second half of the year has been dominated by volatility. The market's highest-priced growth stocks have seen enormous selling pressure, and it no longer looks as if the market is willing to accept sky-high growth multiples for high-flying tech stocks.

Stick to the basics

More volatility means more opportunities for value investors, and it is important at this time to remember the underlying principles of value investing. One of the best articles that has ever been written on value investing principles was written by Warren Buffett (Trades, Portfolio) in 1984 commemorating the 50th anniversary of Ben Grahama's "Security Analysis" and is called The Superinvestors of Graham and Doddsville.

"The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market. Essentially, they exploit those discrepancies without the efficient market theorist's concern as to whether the stocks are bought on Monday or Thursday, or whether it is January or July, etc."

Buffett wrote the article at a strange time in the markets, and he wanted to prove that value investing is not a random exercise. By following a set of principles and investing in businesses at attractive valuations, he tried to show that you could outperform the market over the long term.

"Incidentally, when businessmen buy businesses, which is just what our Graham & Dodd investors are doing through the purchase of marketable stocks -- I doubt that many are cranking into their purchase decision the day of the week or the month in which the transaction is going to occur. If it doesn't make any difference whether all of a business is being bought on a Monday or a Friday, I am baffled why academicians invest extensive time and effort to see whether it makes a difference when buying small pieces of those same businesses."

This remains entirely true today. Buying a share in a business is just the same as buying part of a business.

Over the past decade, as equity markets have trended endlessly higher, it seems many market participants have started to ignore this principle, investing in companies purely because they are going up and not considering the underlying businesses. Now, it seems that investors are starting to reconsider their approach. The endless supply of free money created by quantitative easing is finally coming to an end, and companies that have come to rely on this infinite supply of cheap money and financing to fund their growth at any cost are having to reconsider their options. Buffett went on to say:

"Can you imagine buying an entire business simply because the price of the business had been marked up substantially last week and the week before? Of course, the reason a lot of studies are made of these price and volume variables is that now, in the age of computers, there are almost endless data available about them. It isn't necessarily because such studies have any utility; it's simply that the data are there and academicians have [worked] hard to learn the mathematical skills needed to manipulate them."

Even though it was written more than three decades ago, this advice remains relevant today.

Considering that information has become more prevalent over the past decade, you can argue this is even more relevant today than it was when Buffett first wrote the article. There are now thousands of different funds, following different thematic themes. Investors have never had more options to consider. In this environment, it is important to remain level-headed and stay focused on finding value, despite all the distractions out there.

Disclosure: The author owns no share mentioned.

Read more here: 

Warren Buffett's Best Business Decision

Warren Buffett's Top 5 Holdings

Dodge & Cox’s Top 5 Holdings as of the 3rd Quarter

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website

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