This is part one of a multi-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.
Anurag’s new book is one of the most informative books on value investing, and investing in general, I’ve had the pleasure to read. The book takes a step back from the normal “follow this strategy and you’ll make millions” approach, instead it lays out a framework, which will help any investor deepen their understanding of the value approach, stock ownership and security analysis in general. From Amazon:
“Book of Value teaches novices that investing is not a game of luck but a skill?and it teaches the emotional and analytical tools necessary to play it well. Intermediate investors learn how to effectively control emotions when investing and think strategically about their investment program. Advanced investors see the formalization of what they already know intuitively: that the philosopher’s methods for seeking truth can be profitably applied to make smart investments. A groundbreaking guide full of lasting value, Book of Value should be on the shelf of anyone who takes investing seriously.”
Author Interview: The Book Of Value [Pt. 1]
Rupert Hargreaves: Could you give our readers a brief summary of your book, Book of Value
Anurag Sharma: Sure. The book formalizes the principles of value investing and shows how to apply them to build stock portfolios.
Value investing focuses attention on qualitative factors that make businesses great. Given that economic value depends on the ability of a business to continue generating growing net cash flows over time, value investing requires a deep understanding of such things as business model, leadership quality, strategic clarity, and execution—factors that strongly influence such abilities. The quality of the business is of great concern to value investors, and their assessments are based largely on subjective but rigorous evaluations of a range of things that are difficult to quantify.
Value investing is fundamentally different from the current dominant approaches, like Modern Portfolio Theory (MPT). Whereas MPT relies exclusively on quantitative approaches and is a framework for portfolio-level analysis, value investing emphasizes a holistic, qualitative understanding of individual securities in the portfolio.
This difference has important implications for investment policy, which I discuss in the last five chapters of the book. For example, whereas MPT emphasizes broad diversification and frequent re-balancing based on quantified measures of risk, value investing emphasizes sensibly manageable diversification based on qualitative understanding of the mechanisms for wealth creation and the magic of compounding.
Here is the thrust of my argument in the book:
Markets are incredibly noisy, full of half-baked opinions, misinformed assertions and deceptive innuendo, all conspiring to agitate the mind, making it difficult for investors to make wise choices. Successful investing requires a robust intellectual framework to help investors calmly sort through such noises and hone in on the right signals of economic worth or value.
In the first half of the Book of Value, I offer such a framework for investing (see Figure 9.1), the core element of which is the principle of negation. I show how to set up an investment thesis and test it by systematically trying to refute it. That is, for a thesis to be valid and correctly reveal a potentially good investment, it must face the risk of rejection. If repeated attempts to disprove it fail and the thesis survives a volley of well-aimed data-driven attacks, then the investor may commit capital to it with confidence.
In the second half of the book, I show how to apply the investment choice framework to build high-performance stock portfolios: apply the principle of negation to try to reject each security under consideration. That is, I present a process for developing a strong qualitative understanding of the investment thesis—by putting it through a battery of quantitative and qualitative tests to probe it from different angles. Only when the thesis survives such refutation attacks does it qualify for inclusion in the investment portfolio.
So, the choice framework is, in fact, a rigorous investment process for discovering value.
In all, I make a simple argument: value investors can build substantial wealth over time by being selective about what they put in their investment portfolios.
RH: What was the inspiration behind the book?
AS: For one, value investing is often misunderstood as looking for cheap securities, as measured by current earnings or book in relation to prevailing prices. Far from it, value investing is a state of mind, a view of the world in which investors are constantly evaluating companies for how well they are managed, how strong their economics are, and what returns they provide on invested capital, consistently over time. That is, value investors look for opportunities to deploy capital to best possible uses. Period. So part of my objective in writing the book was to clarify the importance that value investors assign to carefully allocating capital. Value investors are capitalists in the best sense of the word.
My second reason for writing the book was to get academic colleagues to pay more attention to value investing. As it stands now, value investing is the orphan child in business schools. No academic department owns it and there appears to be no systematic research on how to incorporate subjective but rigorous evaluations of value into investment analysis and portfolio construction.
This dearth of academic interest is in part because value investing is a trans-disciplinary enterprise, which makes it difficult to be grasped by specialists who populate the different departments. Traditional finance researchers don’t distinguish between price and value, for instance, and they have a methodological bias towards quantitative approaches such that qualitative issues don’t quite figure in research and teaching. Traditional strategy and organization researchers understand how organizations work but are not particularly interested in market processes. Because of intense specialization in business schools, many powerful concepts remain scattered among specialists in departmental silos. The integrative thinking necessary for value investing is largely missing from investment education.
It is not that specialists are incorrect; just that the demands of specialization make it difficult for specialists to see the whole beyond the parts. This is evident in some measure from the fact that cross-disciplinary citations among the top journals in Accounting, Finance, Management, and Marketing journals are infrequent. This is because of the tight editorial control of the journals by successful and committed specialists who are loath to publish research that does not meet their internal standards. Interdisciplinary research is, therefore, very difficult to publish in top journals.