Value investing was pioneered by
Ben Graham, Warren Buffett’s teacher. Graham thought the best way to make money was to buy businesses when they are undervalued, wait for the market to realize its mistake, and then sell them when they were bid up to retail… and in all fairness to my people, that does sound a lot like my way of doing things.
However, Graham went on to define what “
undervalued” meant to him.
He didn’t think anything was undervalued unless it could be bought for less than its liquidation value. In other words, he didn’t put any value on the business as an enterprise that produced surplus cash. It was undervalued if he could liquidate it and come out okay.
Not that he was in the business of liquidating businesses – he just assumed that the business was so undervalued that eventually, someone besides him would realize it and the price would go up.
Warren Buffett loves his mentor and gives Graham full credit for teaching him how to invest: Simply buy a wonderful business at a great price and you are certain to make money.
But, Graham was investing during a depression and a world war and businesses were available at liquidation prices.
'It was a lot better, he thought, to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.'
Generally speaking, value investing means buying a stock that has very low PE ratios that reflect low growth rate prospects for the future.
When we applying value investing rule ??
We do indeed try to find cheap stuff, although we prefer it to be wonderful cheap stuff, I’ll buy less than wonderful cheap stuff if:
A) It’s cheap enough
B) It’s consistent and durable enough to be able to determine (A).
Good Stock Prices or High-Quality Businesses?
To that point, what is more important, a really high-quality business or a really good price?
The problem with really wonderful companies, really high-quality companies, is that they don’t go on sale.
As long as everyone knows the business is wonderful, the institutional investors running pension funds and mutual funds will buy it and because they buy it the price goes up until the potential return on the investment has been bid up to the 100-year market average of about a 7% CAGR. See MRFfor an example.
On the other hand, if a business has no Moat and is, therefore, by definition, not wonderful, it’s future cash flow is in doubt and therefore, the current value of the future cash is going to necessarily be quite small.
The Risk Lies in Following Mr. Market
The real risk lies in following Mr. Market. If we do just follow the market, the best we’ll do long term is about 7% average and even that is emotionally tough to get. You’d have to keep your money working in the market through huge price drops, drops that regularly will marked to market, wipe out 50% of your portfolio.
Yes, it does come back in the long run but the question is always ‘how long is the long run?’ At some point in an investor’s life, the long run is too long. The real risk of being in the market in this way is felt as an investor gets close to retirement; the closer the time to live off the money, the more the fear is felt that a market meltdown will destroy the retirement.
This is why retired people go to bonds while Buffett is all-in on stocks.
Always stay rational !!
Moving rationally against Mr. Market, against the crowd, against the prevalent emotion, is the key to risk reduction; the emotion of the mob puts businesses on sale and buying is not risky. A market meltdown is unlikely to affect well-purchased positions for long.
Keep this in mind: If you find yourself excited about a company because everyone is excited about it, or you’re thinking of investing because everyone is thinking of investing, it’s probably time to take a big step back.
CONCLUSION
Stick to buying businesses that are durable when Mr. Market puts them on sale and you’ll retire wealthy and stress-free. And the key thing that makes a loser a loser is that you bought a bad business at a terrible price.
Now go play !
Comments
Post a Comment