The Website for
This is something I wish I had, a website summarising all of the most important value investment principles, but instead, I had to read many incredibly thick books and listen to hours and hours of interviews of many of my role models. I admit I enjoyed it, but for those who are not as weird as I am and wouldn’t enjoy it, this website is for you.
Obviously, there is no perfect algorithm or formula for investing. Maybe Ray Dalio at Bridgewater Associates has something close to it but nevertheless, here we discuss not macro-investing but value-investing. No matter the empirical evidence for its great performance over time, value-investing is considered one of the most mundane strategies and therefore is not popular.
But I may ask you, what is more exciting than minimizing risks and investing rationally?
How this page will aid you with Investment Decisions
“The single greatest edge an investor can have is a long-term orientation” – Seth Klarman
The Philosophy behind Value Investing
The short version: “We seek out undervalued stocks of companies we understand in growing industries with honest, capable management.
“Value Investing is easy. You do not need an incredibly high IQ or a specific higher education to succeed. However, what you will need is the ability to stay rational and the right temperament. Greed and fear should not be able to control you and instead, you need the temperament to be able to take advantage of others greed and fear. If you are not confident in the ability to stay rational when emotions take over your peers then this might be not the right thing for you. There is no shame in admitting that. Quite frankly, simply invest in an S&P 500 ETF and you will still beat 90% of hedge fund managers. (Force yourself to invest regularly and apply a buy&hold strategy so you do not sell at a bad timing)
We Value Investors reject the efficient-market theory which states that security prices are always efficiently priced given all the information that is available. Academics love this theory and it is also one of the first things I was thought in my finance course at university. In my opinion, this theory is bull***t and clearly not scientific. If you are familiar with Popper’s logic of methodology you would argue that immunization of a theory is a huge weakness and unscientific.
Imagine a scenario where security prices drop 50% after a speculative bubble burst. They will tell you that the theory is perfectly fine as the change in security prices reflects the changes in people’s expectations and therefore the prices were and are efficiently priced at all times. While technically correct I find this incredibly irresponsible and quite frankly useless.
In comparison, investors should think of Mr. Market as a symbolization for the stock market. A bipolar person who buys and sells securities each day depending on his mood.He reflects the psychology of the masses. It is important to really understand that security prices are simply set by demand and supply. And this demand and supply are just as much influenced by emotions as it is by the fundamentals. When he is euphoric he will buy securities at prices at irrationally high multiples while when he is depressed he might sell you a security at a price below its intrinsic value. We want to take advantage of him.
In our current market climate with low-interest rates, developments in technology and people forgetting about the last recession it is easy to become greedy. This is where Warren Buffets insight is very important “Be greedy when others are fearful and be fearful when others are greedy”. When people around you are becoming rich quickly with exciting speculations in “the next big thing” you might feel like you are missing out and should do what they do too. A natural human emotion which can cost you a lot of money. Nobody wants to become rich quickly. This is why there are so few value investors relative to the empirical evidence of its long-term success. Why invest in boring firms which just provide you with stable cash flow when you can invest in bitcoin and have a potential return of xxxx%?
I’ll tell you why. There are three important principles which build upon each other. 1) Learn from history, 2) Speculation is not Investing, 3) Don’t lose money.
History repeats itself in a similar way because while the world landscape does change, human nature does not. Therefore, it is a great reference to learn from. Every decade there is the next “big thing” and historically you would have lost a lot of money investing in them. Usually, because it’s just a fad or if it actually lasts then the price you have paid for already incorporated its future growth by a multiple. Empirically you would have done a lot better investing in boring but healthy firms which provide you with stable cash flow.
Speculation is not Investing! Betting your money on something because you believe it will go up in price without sound reasoning is gambling. “real estate is always a good investment because the prices will always increase” – No it’s not. “security XYZ is a sound investment because everybody buys it and it has been going up in price for years”- No it’s not. A fool believing that a greater fool will buy the security from him for a greater price in the future is still a fool. Not realizing this can be very dangerous. Some people will make some great returns during a bull market by speculating. They will think it’s because they have a brilliant mind and will become overconfident in their abilities. Not realizing that they are simply ducks rising with the high tide. In reality, most of them have not even looked at the financial statements of the firms they invest in. It is mind baffling how some people put more research into what kind of smartphone they buy compared to where they put their life savings. The lesson here is that you will need years maybe even more than a decade to see if somebody knows what they are doing in the stock market and if they are not simply ducks floating on the sea. I personally would not take investing advice from somebody who has won three times in a row by betting on red in roulette. Would you?
The most important principle is not to lose money. It sounds simple but many ignore what it actually means. One should minimize the probability of losing money on an investment. This differentiates speculators from value investors as well. Speculators only care about the momentum and what kind of easy return they can make. Value investors primary goal is loss aversion. A 20% decline in your investment mathematically requires a lot more than a 20% increase to breakeven. One should also take into account the opportunity cost of capital of waiting for your investment to breakeven after such a drop in price. In most cases, this will take years and in some cases, it will never again reach those inflated prices. A value investor realizes this and invests only with a margin of safety. He only buys a business when he believes that it is undervalued – the asking price is below its intrinsic value or it is fairly priced. A value investor has the ability to become greedy when others are fearful and go on a shopping spree when others are selling because his buying decision only depends on the fundamentals and its price. Therefore, while a value investor may seem to perform not as well during bull markets, he will perform better during bear markets and in the long-term will beat all other market participants.
Due to the nature of Value Investing we do not need to take into account what others are doing and how the market is developing. We simply answer two questions: ‘1) What company to buy?’ and ‘2)What price to pay?’.
Of course, the philosophy behind it is more extensive than what I have provided you with. However, this is supposed to be a summary and outline of the basic principles. If you want to learn more scroll down to the section where I have included a booklist. It includes the classics and other relevant literature written or endorsed by the legends of value investing themselves.
Some of the most renowned Value Investors who we learn from
Benjamin GrahamThe father of value investing. The mentor of Warren Buffett and the author of the investment bibles ‘the intelligent investor’ and ‘security analysis’.
Seth KlarmanHe is the Chief executive and portfolio manager of the Baupost Group, a hedge fund located in Boston. He is the most successful investor you probably haven’t heard of.
Warren BuffettThe founder of Berkshire Hathaway really needs no introduction. He is called the Oracle of Omaha and is the face of value Investing.
Joel TillinghastJoel manages several portfolio using the value investment approach for fidelity. SmartMoney Magazine calls him one of the world’s greatest investor and so do I..
Peter LynchMr. Lynch was Joel Tillinghast’s mentor and is still the face of Fidelity. Just like Mr. Buffet he is a household name.
Joel GreenblattIncredibly successful investor and professor at Columbia School of Business. He might be the reincarnation of Benjamin Graham.
- Do I understand the business well enough? (why do customers buy the company\’s product? what makes the company better than its competitors? How does the business make its money? etc.)
- Is the country in which you invest well governed and not a war zone? (you don\’t want to invest in countries where private property is not respected)
- Does the company product superior products or cheaper products than its competitors? (if there is a choice, quality is the better way to go)
- Does the company have a high and stable ROCE? (this is a indication for great capital allocation)
- Is the CEO\’s pay package similar to those of CEO\’s of like-sized companies? (If not, the board of directors is likely an inside board)
- Does the CEO have a criminal record, history of cheating investors or feels above the law? (red flag! abort!)
- The financial reports are easy to read and do not have too many footnotes. (If this is not the case they might be trying to hide something.)
- The company does not have a negative free cash flow every year, climbing debt, and increasing shares outstanding. (If it does, these are great clues for fake earnings.)
- The company does not have rapid growth of assets like inventory and recievables. (often this is a sign for a company being in trouble)
The four elements of value are profitability/income, life span, growth and certainty.
- The company has low production costs.
- The company has a discount to asset value.
- The company has a low p/e ratio.
- The company has little or no debt.
- The company is not a technology company (there is no Warren Buffet of technology -> too easy to fail without innovation -> nothing endures in tech)
- The company does not produce fad products or operates in commodity-like industries (obsolesce is foreseeable / too many competitors.)
- The company is not in the following industries: autos, airlines, shipping, steel or coal. (practically impossible to offer anything that competitors won\’t quickly knock off.)
- The business respects the matching principles. (borrowing with safe assets, and match long-term assets with long-term debt)