Hi David,

Love the blog. I am an MBA student and obsessed with the value investing philosophy. There are two points that  could use clarification.

  1. There are so many value investors today, does that mitigate potential rewards? Does value investor competition create less value?
  2. Towards the end of Grahams career he said ” I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities”  This was disheartening to read, but I saw that Jason Zweig commented that Graham was only referring to passive investors.Graham seems to imply otherwise. Any thoughts?

I would really appreciate a response.

All the best.

No, Ben Graham Did Not Give Up on Value Investing

So wrote one of my readers.  I’ll try to answer both of the questions.

The answer to the first question is relatively simple.  Any strategy can be overused relative to the degree of mispricing in the market.  There can be too many value players.  There can be too many momentum players.  There can be too many investors aiming for dividends, low volatility, high quality, etc.

If you are the only one with a strategy, you can make a ton off of it.  Think of Ben Graham back in the 30s, 40s & 50s… there were few people kicking the tires on seemingly troubled companies that had a lot of unused assets.  It was easy to make a lot of money in that era, for the few that were doing it.

Phil Fisher was a growth investor with a singular insight — look for sustainable competitive advantage, or in the modern parlance, a moat.  He racked up quite a track record in the process.

Or think of Sam Eisenstadt who developed the core of Value Line, building on the ideas of Arnold Bernhard.  He was way ahead of GARP investing by incorporating price momentum, earnings momentum, earnings surprise and valuation into one neat method.  It took a long time before those anomalies were exhausted.  It worked for 50 years or so.

Or think of Buffett, who synthesized many strands of value investing together with an insurance holding company, levering up value investing with an aim of rapid compounding of profits.

Any valid strategy with few users will reap relatively high rewards.  When lots of people pursue it, relative rewards fall.

Value investing has two things going for it that tends to reduce the tendency for the rewards to be played out.  It takes effort, and it’s not sexy.

Value investing can be taken to as deep of a level as one wants.  Sometimes I read the analyses of other value investors, and I say to myself, “This is either masterful, or he had a lot of time on his hands.”  I tend to be more simplistic, realizing that the first 20% of the analysis releases 80% of the value.  I am also a better portfolio manager than I am an analyst, though I’ve had people say to me that my intuition is sharper than many.  (I don’t know.)

The “not sexy” aspect of value investing partly stems from a desire to invest in things that are growing rapidly, because there have been notable growth companies that have made their investors a lot of money.  Why else do you see articles “This stock is the next Microsoft Corporation (NASDAQ:MSFT), Apple Inc. (NASDAQ:AAPL), Google Inc (NASDAQ:GOOG), etc?”  Creating the next Chevron, IBM, or Berkshire Hathaway would take a lot of time, relatively.

Every now and then, value investing gets crowded, but the advantage never fully goes away for a long time.  Besides, market events like 1973-4, 1979-82, 1987, 1998, 2002-3, and 2008-9 shake up things so that there are a crop of new opportunities.  As I said to my boss in 2007 when he was giving me a bad review, “When I came here in 2003, it was as if the applecart had been knocked over, and easy values were easily picked up, like apples.  Today, there are no easy pickings.”

Okay on to question 2.  Part of the problem here is the famous part of what Graham had to say is well-known but the whole article is not well-known.  Here is the whole article.  And here is the famous quote, again:

In selecting the common stock portfolio, do you advise careful study of and selectivity among different issues?
In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I’m on the side of the “efficient market” school of thought now generally accepted by the professors.

On the face of it, to a value investor, this is rather disheartening.  Who wants to see the founder abandon the heritage? But I mostly agree with Jason Zweig, because this has to be taken in context with the other things he said in the FAJ article.  Let me explain:

First, since Ben Graham, we have discovered a wide number of anomalies in investing: earnings quality, momentum, distress, asset shrinkage, share shrinkage, neglect, etc.  We haven’t been impoverished because we no longer have net-nets (cheap companies with unused assets) to invest in.  We’ve sharpened the discipline beyond what Ben Graham could have imagined.

Second, if you read the full article, Ben Graham still defends value investing:

Turning now to individual investors, do you think that they are at a disadvantage compared with the institutions, because of the latter’s huge resources, superior facilities for obtaining information, etc.?
On the contrary, the typical investor has a great advantage over the large institutions.
Chiefly because these institutions have a relatively small field of common stocks to choose from–say 300 to 400 huge corporations — and they are constrained more or less to concentrate their research and decisions on this much over-analyzed group. By contrast, most individuals can choose at any time among some 3000 issues listed in the Standard & Poor’s Monthly Stock Guide. Following a wide variety of approaches and preferences, the individual investor should at all times be able to locate at least one per cent of the total list–say, 30 issues or more–that offer attractive buying opportunities.
What general rules would you offer the individual investor for his investment policy over the years?
Let me suggest three such rules: (1) The individual investor should act consistently as an investor and not as a speculator. This means, in sum, that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money’s worth for his purchase–in other words, that he has a margin of safety,

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