This is the final part of a three-part interview with Anurag Sharma, author of a new book on value investing, Book of Value: The Fine Art of Investing Wisely. The interview is part of ValueWalk’s Value Fund Interview Series.

Throughout this series, we are publishing weekly interviews with value-oriented hedge funds, and asset managers. All the past interviews in the series can be found here.

The first part of the interview, along with an introduction to the book and a brief summary can be found here: Author Interview: The Book Of Value [Pt. 1]

Part two is here: Author Interview: The Book Of Value [Pt. 2]

book of value
Author Interview: The Book Of Value

Author Interview: The Book Of Value [Pt. 3]

Continued from part two….

RH: What experiences have shaped you personally as an investor?

AS: Losses. Nothing gets one’s attention like the pain from losses, especially those resulting from unforced errors. I made some mistakes when I first started investing and those forced me to review my decision processes—why did I make those mistakes?

One particularly tough mistake was my investment in Movie Gallery. They were a well-positioned chain of video rental stores in the rural south but expanding quickly by rolling up small chains in rural areas across the country. The company did well for some years and then got into a bidding war with Blockbuster to overpay for Hollywood Entertainment, which was largely a suburban chain directly competing with Blockbuster. The acquisition took them outside of their core rural markets, and the increased debt burden along with poor execution made them vulnerable shifts in movie rental/viewing habits. I ignored the changes and hung on too long. It ended badly. It was a typical rookie mistake: the facts on the ground had changed but I clung to my original thesis. I had failed to update my original thesis by wishfully ignoring the fact that Hollywood was clearly a bad acquisition which made them strategically weak and for which they overpaid.

Reflecting on this mistake made me realize that there was something not right about my decision processes. Why was I so resistant to re-evaluate and change my thesis? Why did I ignore the changed facts on the ground? I understood that the problem I had was as much psychological as it was analytical. Over time, as I reflected and read more broadly, I began crystallizing the negation principle, which eventually became central to my thinking about how to be a value investor.

Also, I see many of my students struggling to grasp the principles of value investing. The finance curriculum in business schools is dominated by modern portfolio theory and efficient market hypothesis, both of which essentially deny the value of deep fundamental analysis. So, I wanted to formalize an alternate intellectual structure that helped my students frame investment decisions as choices about capital allocation. Book of Value is the result of that intent.

RH: Do you think individual investors damage their own chances of success by trying to emulate famous investors without first understanding their strengths and weaknesses? 

AS: Individual investors can learn a lot from famous investors, especially about temperament and mental habits. But the most important thing to understand about famous investors is that they are fiercely independent thinkers; they are their own persons. Even when they acknowledge intellectual debt to others, successful value investors rely on their own way of making sense of the financial markets and evaluating individual securities. They adapt the basic principles of value investing to who they are: they understand themselves, do their work, steady their emotions, and make the calls while keeping in mind the economic fundamentals that drive performance. Free riding on the work of others is not what makes investors good at their craft.

RH: You talk about looking for ‘good businesses’ in the book. Without giving too much away, how would you define a ‘good business.’ 

AS: I define good business as “one that, on average and over time, consumes a dollar to produce a stream of cash that, when appropriately discounted, amounts to something more than a dollar.” Of course, it takes a lot to durably and consistently generate net positive cash flows, so investors need the analytical skills and techniques to discern whether a company can do so. This requires focus on qualitative factors such as leadership and a clear-eyed assessment of the business model, financial statements, and competitive context. Experienced value investors have the mental orientation and analytical horsepower to do so.

RH: And lastly, another topic you cover in the book is something called ‘the Buffett portfolio.’ What is ‘the Buffett portfolio’ and why do you believe it’s important for investors? 

AS: The Buffett Portfolio is Chapter 25 of the Book of Value. I included it to illustrate a master value investor at work, deftly compiling a stock portfolio which looks deceptively simple but one that leverages deep appreciation of what makes a good business and how good leaders create economic wealth. Good business operated by good managers, purchased at sensible prices: this remains his mantra for taking minority equity positions in companies or for buying them whole.

The Buffett portfolio is interesting in that the constituent companies seem to have been carefully selected one at a time, accomplishing broad sector diversification without much regard to variance-covariance matrices, standard deviations, or betas. The focus is on company analysis, one company at a time. Also important to note is that the portfolio has low turnover and is concentrated in holdings that have performed well over time, validating the criteria used for selection when they were first purchased.

Perhaps most important, the Buffett portfolio also reflects caution, diligence, and above all patience—all virtues of a good value investor.