Before we answer this question “Is Value Investing Really Dead?”, it’s important for all of us to understand what REALLY is value investing all about.
Many of you are probably familiar with the term value investing and see Warren Buffett as the poster boy for it. But did you know that this method started out very differently from Buffett’s famous investments like See’s Candies, Coca-Cola and Apple?
To know how value investing evolved, we have to know who is Benjamin Graham – who is also known as the Father of Value Investing.
When Graham first penned down his thoughts about investing in his book, Security Analysis, the term ‘value investing’ wasn’t even coined yet. But to Graham, he already had his own distinct ideas on how to differentiate a company’s stock price and its intrinsic value.
Security Analysis’s first edition was published in 1934 and America had just gone through one of the most severe economic recessions in the 20th Century – called the Great Depression of 1929. The stock market collapsed as well and there were many publicly listed companies that were worth more dead than alive.
In other words, those companies were selling for less than their liquidation values. Graham’s analysis was very much on the Balance Sheet – a document that tracks what those companies owned and owed.
In fact, Graham ran his own very successful hedge fund, the Graham-Newman Corporation (which had annual returns of around 20% from 1936 to 1956), using a technique which relied extensively on Balance Sheet analysis.
The technique was called Net-Net and it can actually be expressed in a simple formula:
Net-Net = Current Assets – Total Liabilities
Graham wanted to find stocks that were selling at two-thirds its Net-Net value because he wanted a Margin of Safety. He knew that stocks selling at such depressed valuations were often in trouble in some way or another and so, wanted to use a very low buying price as a buffer in case things did not work out.
To increase his odds of success, Graham also diversified widely, with some accounts saying he had more than 100 stocks in his portfolio at any one time. By diversification, he allowed the natural laws of statistics to play out with the stocks in his portfolio. Surely, such cheap stocks will rebound in price as people realised the folly of leaving a company worth more ‘dead than alive’, especially when they had minimal debt loads and were still making profits, Graham thought.
Graham’s investing style could not be more aptly named than ‘cigar-butt’ investing. Buffett coined the term when he described Graham’s value investing methods as finding a used-cigar butt lying on the ground that was still good for one final puff – it did not cost a cent and could still provide one enjoyable puff.
Perhaps, Graham’s greatest legacy was leaving the world with the concept of a ‘margin of safety’ – making sure your purchase price is low enough to mitigate any potential mistakes in evaluating a business’s intrinsic value – and Mr. Market.
Mr. Market’s an allegory for the stock market as Graham likened the stock market to an individual suffering from bipolar disorder. The stock market can be extremely euphoric at times, resulting in overpriced stocks, which gives you an opportunity to sell, and then swing to despair, resulting in severely under-priced stocks, which gives you an opportunity to buy.
As Graham’s student in Columbia Business School, those were the greatest lessons Buffett learned from his teacher. But, how did Buffett end up investing in businesses that could grow their profits surely over the years?
In the early days, Graham taught an investing course at Columbia Business School, which Warren Buffett had attended. After Buffett’s graduation from Columbia, he eventually ended up working for Graham at his investment firm, the Graham-Newman Corporation (GNC).
People familiar with the term value investing in modern times might associate it with Warren Buffett and the analysis of a business’s ability to generate above-average and sustainable profit margins and cash flows.
Buffett wants to find compounders – companies that can grow intrinsic value over time. Sometimes, such method of investing is also as “Growth Investing” today which is in fact, a modern type of Value Investing.
So is Value Investing REALLY Dead? Not really.
DISCLOSURE
The above article is for educational purposes only. Under no circumstances does any information provided in the article represent a recommendation to buy, sell or hold any stocks/asset. In no event shall ViA or any Author be liable to any viewers, guests or third party for any damages of any kind arising out of the use of any content shared here including, without limitation, use of such content outside of its intended purpose of investor education, and any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages resulting from such unintended use.
