Value Investing General Principles
Fordham University – Gabelli Center for Global Security Analysis
March 8, 2015
Since the financial crisis, Warren Buffett's Berkshire Hathaway has had significant exposure to financial stocks in its portfolio. Q1 2021 hedge fund letters, conferences and more At the end of March this year, Bank of America accounted for nearly 15% of the conglomerate's vast equity portfolio. Until very recently, Wells Fargo was also a prominent Read More
This paper profiles what I believe are core value investing general principles. In my work as a corporate financial and strategic advisor, I have observed a need for such an exposition because core value investing theory is not well understood by many corporate executives. Two anecdotal examples will illustrate this: (1) While speaking with a C-level executive about a potential acquisition he was contemplating, I mentioned the practical insights that a value investing-based analysis could provide. He replied, “We have a lot people running dividend discount models so we’re good there.” He looked at me funny when I replied that such models were not at all what I meant by a value investing-based analysis, and (2) While speaking with another executive about an acquisition I again broached the topic of value investing-based analysis to which he replied, “I know all about that and already ‘buy low and sell high.'” I observed that, given his acquisition history, he was not “buying low” and, further, that there was a great deal more to value investing than that. While this paper is introductory in nature, more experienced readers may be interested in how I interpret and profile the general value investing principles they are familiar with.
“Both medicine and security analysis partake of the mixed nature of an art and a science; in both the outcome is strongly influenced by unknown and unpredictable factors; in both we may find–in Henderson’s phrase–‘the concealment of ignorance, probably more or less unconsciously, with a show of knowledge.'” — Benjamin Graham
“Valuation is an art, not a science.” — Seth A. Klarman
“Investing, like economics, is more art than science. And that means it can get a little messy.” — Howard Marks
Value Investing General Principles – Introduction
Like many people I admire Thomas Edison and, also like many people, I have visited his New Jersey factory, which is now a museum. On my first visit there I noticed a sign that quoted Sir Joshua Reynolds, which Mr. Edison prominently displayed above the factory time clock immediately in front of the building’s entrance. It reads as follows: “There is no expedient to which a man will not go to avoid the labor of thinking.” What an odd quote, I thought at the time, for your employees to see as they check in for work.
When I was trading, many people said they put a premium on being a “contrarian” (Principle 1). One of the classic books on this subject is The Art of Contrary Thinking by Humphrey Neill, which begins with this definition: “The art of contrary thinking may be stated simply: Thrust your thoughts out of the rut. In a word, be a nonconformist when using your mind…. Let me give you an easily remembered epigram to sum up this thought: When everyone thinks alike, everyone is likely to be wrong” (emphasis original). This is a classic definition, but the way it is worded can lead pretty much anyone to think they are a “contrarian,” which of course they are not for as James Grant has insightfully observed, “What money can’t buy—what brains frequently don’t contribute—is a precious, non-consensus view of the future.”
Professional value investors are very much “contrarians” because they understand, as the school’s founder Benjamin Graham did, that “You may take it as an axiom that you cannot profit in Wall Street by continuously doing the obvious or popular thing.” As value investor Howard Marks has observed: “Accepting the broad concept of contrarianism is one thing; putting it into practice is another.” Michael Lewis explains why in his first bestselling book, Liar’s Poker:
Everyone wants to be [a contrarian], but no one is, for the sad reason that most investors are scared of looking foolish. Investors do not fear losing money as much as they fear solitude, by which I mean taking risks others avoid. When they are caught losing money alone, they have no excuse for their mistake, and most investors, like most people, need excuses. They are, strangely enough, happy to stand on the edge of a precipice as long as they are joined by a few thousand others. But when a market is widely regarded to be in a bad way, even if the problems are illusory, many investors get out.
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