Value Investing Not ‘Hot,’ But Profitable by Tim Melin, Benzinga
In chapter two of his classic book, “The Intelligent Investor,” Benjamin Graham spelled out what it takes for investors to succeed:
The investor cannot enter the arena of the stock market with any real hope of success unless he is armed with mental weapons that distinguish him in kind, not in a fancied superior degree, from the trading public. One possible weapon is indifference to market fluctuations; such an investor buys carefully when he has money to place and then let’s prices take care of themselves.
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But, if the investor intends to buy and sell recurrently, his weapons must be a frame of mind and a principle of action, which are basically different from those of the trader and speculator. He must deal in values, not in price movements. He must be relatively immune to optimism or pessimism and impervious to business or stock market forecasts.
In a word, he must be psychologically prepared to be a true investor and not a speculator masquerading as an investor. If he can meet this test, he will be a member not of the public at large but of a specialized and self-disciplined group.
The amazing thing about that passage is that it was penned 65 years ago, but today there is only a handful of investors who meet the test of true investing. Graham’s criteria for identifying undervalued securities has been in the public realm since the publication of the 1934 edition of “Security Analysis.”
In “The Intelligent Investor,” he outlined the proper approaches for both defensive and enterprising investors. In a series of articles and interviews published shortly before his death in 1976, he outlined a formulaic approach to stock selection that investors can use to achieve superior returns. The information is readily available, and yet it seems no one uses it still today.
It’s not like it all stopped working at some point in time. In his book, “The Net Current Asset Value Approach to Investing,” Victor Wendl demonstrates that using this basic value technique has beaten the market over the past 60 years.
In their book, “Quantitative Value,” Tobias Carlisle and Wesley Gray showed that Graham’s simple quantitative value methodology described in the 1970s compounded at more than 17 percent a year from 1976 to 2011, easily beating the S&P 500’s 11.05 percent return over the same time.
On his website Greenbackd.com, Carlisle published a study that showed how an equally-weighted portfolio of the cheapest stocks based on price-to-book value returned 20 percent annually from 1951 to 2013.
Vera Yuan of GuruFocus.com published a study that looked at stocks and several different characteristics from 2000 to 2012.
“Often ignored these days, (price-to-book value) is actually the parameter that has the most correlation with the stock performance,” the study concluded.
Value investing firm Donald Smith & Co. has a study on its website showing that the cheapest stocks as measured by price-to-book value earned 15.4 percent from 1951 to 2009.
Warren Buffett once commented, “You either get value investing right away or you never do.”
Form Over Fashion
It would seem that most people just cannot grasp the simple concept of buying undervalued securities and selling overvalued ones. “Buy low, sell high” makes sense to most of us when shopping for a new car or groceries. When it comes to our investment portfolio, however, we have a preference for excitement, regardless of cost.
The tendency for individual investors to over-trade their accounts and chase hot stocks while underperforming the indexes is well known. In spite of this, most investors own the same stocks everyone else does and move from hot stock to hot stock looking to win the short-term performance game.
Buying undervalued shares of companies that have a margin of safety in the balance sheet is a proven approach to building wealth in the stock market.
It is not flashy or terribly exciting on a day-to-day basis. It does require more work and study than just merely drawing lines on a chart or buying what friends are buying. One must have the fortitude to buy when others are selling and sell when stock tips and chatter are the order of the day in a hot market.
A broker probably will not like when someone holds stocks for a long period of time, but accountants will have a favorable opinion of those who pay less fess, defer taxes on long-term gains and build net worth at an impressive rate over time.
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