Pretty much every person, even those outside the investments world, know about Warren Buffett. He is the world’s most famous investor, and arguably one of the best too. In over six decades of investing, Mr. Buffett has amassed a fortune that’s more than $80 billion, making him one of the richest people in the world.
Warren Buffett follows a particular investing style/framework called “value investing“. While Buffett has made this investment style popular all over the globe, with his continued success & fame, it’s actually not something that he came up on his own.
Instead, he learnt it from one of his professors at Columbia Business School in the 1950s – the “father of value investing”, Benjamin Graham.
He earned that title because of his two books – Security Analysis and The Intelligent Investor, which literally define what the value investing philosophy is and what it truly means to be a value investor. He was one of the first to distinguish between “speculation” and “investing”.
This might seem fairly obvious today, but in the early 1920s/1930s, this wasn’t the case. The stock markets back then were akin to the Wild Wild West – rife with information asymmetry, insider trading, crazy price volatility, and no established framework per se. But Graham believed that the real value of a stock could be determined through proper research, as opposed to mere guessing & speculation.
In 1934, Benjamin Graham along with his fellow-professor at Columbia Business School, David Dodd published their investing methodology/framework in a book called Security Analysis. This provided the initial roots of the value investing framework, making clear distinctions between stock investing & speculating in stocks.
Few years later, Benjamin Graham went on to write what is now considered as the bible of value investing, The Intelligent Investor.
Core Principles of Value Investing
The 640-page book is a mix of practical insights, academic theory, and relevant experiences that highlight the core of value investing. It’s a great read if you’re looking to learn about this strategy – and stock-picking in general. If one had to really summarise the learnings, Graham basically puts forward four core ideas:
- Intrinsic Value: every security has an intrinsic value that is justified by facts like assets, earnings, dividends, etc.
- The Margin of Safety: the lower the current market price of the security relative to its intrinsic value, the higher the Margin of Safety is.
- Mr. Market: Graham urges investors to view fluctuating market prices as if being in business with a partner who is “manic-depressive”, i.e. someone who has constant mood swings that range from depressive lows to manic highs. As such, your partner offers to either sell or buy items (shares) at prices strongly linked with his mental state at each time – and keep in mind that this can switch from highly pessimistic to wildly optimistic in a short time.
- Diversification: finally, Graham advocates that value investors should diversify their portfolio – this helps in better managing the risks involved.
Along with the above, Graham was also an advocate of long-term investing. In his opinion, this not only increased the chances of your thesis playing out but it also helps in ignoring the short-term fluctuations that are subject to Mr. Market’s mood swings.
The “Mr. Market” analogy is honestly one of the most interesting I’ve ever come across, and one that’s perhaps still as relevant (if not more). Graham goes on to describe that while you might be stuck with Mr. Market as your business partner, it’s super important to have your own views & opinions. In The Intelligent Investor, he writes:
“You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.“
Becoming a Value Investor
Benjamin Graham’s principles boil down to finding quality companies (i.e., companies with high intrinsic value) that are currently undervalued (i.e., companies that have a good margin of safety). If the thesis hasn’t changed, investors should ignore the mood swings of Mr. Market and hold on until the intrinsic value is reached.
To some extent, this is how I behave when I shop for things. I’m a deal-hunter – and as such the first place I check for things is in the “deals” or “sale” section of stores or online marketplaces. Heck, I do that even when ordering food via Swiggy or Zomato. What Benjamin Graham is asking you to do is essentially the same – except in the stock markets where the prices aren’t as clear or well-labeled.
If you’re interested in learning how you can start identifying deals in the stock market, reading The Intelligent Investor is a must. In fact, it’s a good read for anyone who’s broadly interested in learning more about the stock markets in general.
And if you’re looking to invest in “value” stocks in true Benjamin Graham style but don’t have the time/knowledge/interest to find such stocks, take a look at the Bargain Buys smallcase.
In constructing the Bargain Buys smallcase, we have adapted Benjamin Graham’s investment philosophy for the Indian stock market. This smallcase comprises of companies that boast of strong financial position, manageable debt, and stable earnings. Above all, they are available at cheap valuation compared to their intrinsic value (thus having a good margin of safety). Which is the average P/B ratio of this smallcase is an impressive 0.63 vs. 1.44 of Nifty-Smallcap. (Lower the P/B ratios indicate the price of a company is less than the net value of its assets, i.e. if it’s less than 1, it’s at a “discount”).
True to Graham’s philosophy, the portfolio is also diversified – and requires a long-term investment horizon for the thesis to play out, which also makes it a riskier proposition compared to other investment options. But then again, there’s no such thing as high returns with low-risk!
Are you a value investor? If so, what appeals most to you about it? If not, what are some of the drawbacks you find about this investing style? Tweet your thoughts to me at @vikasbardia 🙂