Value investing

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Value investing is a style of investment strategy from the so-called "Graham & Dodd" School. Followers of this style, known as value investors, generally buy companies whose shares appear underpriced by some forms of fundamental analysis; these may include shares that are trading at, for example, high dividend yields or low price-to-earning or price-to-book ratios.

The main proponents of value investing, such as Benjamin Graham and Warren Buffett have argued that the essence of value investing is buying stocks at less than their intrinsic value^[1]. The discount of the market price to the intrinsic value is what Benjamin Graham called the "margin of safety". The intrinsic value is the discounted value of all future distributions.

However, the future distributions and the appropriate discount rate can only be assumptions. Warren Buffett has taken the value concept even further as his thinking has evolved to where for the last 25 years or so his focus has been on "finding an outstanding company at a sensible price" rather than generic companies at a bargain price.

1 History
- 1.1 Benjamin Graham
- 1.2 Further evolution
2 Value Investing Performance
- 2.1 Performance, value strategies
- 2.2 Performance, value investors
3 Well Known Value Investors
4 Other Notable Value Investors
5 References
6 See also
7 Formative Value Investing Books
8 Value Investors at Wikiquote
9 External links

[edit] History

[edit] Benjamin Graham

Benjamin Graham

Value investing was established by Benjamin Graham and David Dodd, both professors at Columbia University and teachers of many famous investors. In Grahams's book The Intelligent Investor, he advocated the important concept of margin of safety — first introduced in Security Analysis, a 1934 book he coauthored with David Dodd — which calls for a cautionary approach to investing. In terms of picking stocks, he recommended defensive investment in stocks trading not far from their tangible book value as a safeguard to adverse future developments often encountered in the stock market.

[edit] Further evolution

However, the concept of value (as well as "book value") has evolved significantly since the 1970s. Book value is meaningful only in some traditional stable industries where the value of an asset is well defined. When an industry is going through fast technological advancements, the value of its assets is not easily estimated. Sometimes, the production power of an asset can be significantly reduced due to competitive disruptive innovation and therefore its value can suffer permanent impairment. One good example of decreasing asset value is a personal computer. An example of where book value does not mean much is the service and retail sectors. One modern model of calculating value is the discounted cash flow model (DCF). The value of an asset is the sum of its future cash flows, discounted back to the present.

[edit] Value Investing Performance

[edit] Performance, value strategies

Value investing has proven to be a successful investing strategy. There are several ways to evaluate its success. One way is to examine the performance of simple value strategies, such as buying low PE ratio stocks, low price-to-cash-flow ratio stocks, or low price-to-book ratio stocks. Numerous academics have published studies investigating the effects of buying value stocks. These studies have consistently found that value stocks outperform growth stocks and the market as a whole.^[2] ^[3] ^[4]

[edit] Performance, value investors

Another way to examine the performance of value investing strategies is to examine the investing performance of well-known value investors. Simply examining the performance of the best known value investors would not be instructive, because investors do not become well known unless they are successful. This introduces a selection bias. A better way to investigate the performance of a group of value investors was suggested by Warren Buffett, in May 17, 1984 speech that was published as The SuperInvestors of Graham and Doddsville. In this speech, Buffett examined the performance of those investors who worked at Graham-Newman Corporation and were thus most influenced by Benjamin Graham. Buffett's conclusion is identical to that of the academic research on simple value investing strategies--value investing is, on average, successful in the long run.

[edit] Well Known Value Investors

Benjamin Graham is regarded by many to be the father of value investing. Along with David Dodd, he wrote Security Analysis, first published in 1934. The most lasting contribution of this book to the field of security analysis was to emphasize the quantifiable aspects of security analysis (such as the evaluations of earnings and book value) while minimizing the importance of more qualitative factors such as the quality of a company's management. Graham later wrote The Intelligent Investor, a book that brought value investing to individual investors. Many of Graham's students, such as William Ruane, Irving Kahn, Walter Schloss, and Charles Brandes went on to become successful investors in their own right.

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Charlie Munger

Graham's most famous student, however, was Warren Buffett, who ran successful investing partnerships before closing them in 1969 to focus on running Berkshire Hathaway. Charlie Munger joined Buffett at Berkshire Hathaway in the 1970s and has since worked as Vice Chairman of the company. Buffett has credited Munger with encouraging him to focus on long-term sustainable growth rather than on simply the valuation of current cash flows or assets.^[5]

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John Templeton

Another famous value investor is John Templeton. He first achieved investing success by buying shares of a number of companies in the aftermath of the stock market crash of 1929. He went on to become famous for investing in global equity markets.

Many successful value investors have gained fame recently. Joel Greenblatt is widely renowned for achieving annual returns at the hedge fund Gotham Capital of over 50% per year for 10 years from 1985 to 1995 before closing the fund and returning his investors' money. He is known for investing in special situations such as spin-offs, mergers, and divestitures. Edward Lampert is the chief of ESL Investments. He is best known for buying large stakes in Sears and Kmart and then merging the two companies.