Bruce Greenwald Class (Jan. 22, 2004) No. 1 On Value Investing: An Overview via CSInvesting
This lecture provides an overview of the value investing process from search strategy to valuation to investment.
Read on his Web-site his buying criteria. You want to learn this process. A part of what Buffett has done is offer a tax dodge. A private company owner can sell to Berkshire in a stock for stock exchange without paying taxes and have a diversified company in exchange.
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Class Case Studies
This is a class in a specific kind of investing. There are two basic approaches. There are short-term investors (preferably not investing taxable money). Many technical investors who do not care about the underlying quality of the companies invest solely on price information. Although some value investors build a time element into their investments. There are investors who look at short-term earnings. Analysts spend their time on earnings’ forecasting. If you think IBM is going to do $1.44 vs. the analyst estimates of $1.40, then you buy IBM, because analysts are behind the real growth in earnings. Your estimate is correct.
Another group, who has given up altogether, they believe the markets are efficient; they index. Unless the distribution is very skewed, then only 50% of the investors can outperform the market.
This is a market for long-term investors with a particular orientation. You look at a security and it will represent a claim on earnings and assets. What is that claim worth?
If you think that a company is worth $22 to $24 per share, then you look to buy with a margin of safety. When the margin of safety is sufficiently large, you will buy. You will look for bargains.
Value Investors constitute only 7% of the investor universe. There is substantial statistical evidence that value investing works: higher returns with lower risks than the market.
Value Investing (“VI”) rests on three key characteristics of financial markets:
1. Prices are subject to significant and capricious movements that can temporarily cause price to diverge from intrinsic value. Mr. Market is to offer you various prices, not to guide you. Emotionalism and short-term thinking rule market prices in the short-run.
2. Financial assets do have underlying or fundamental economic values that are relatively stable and can be measured by a diligent and disciplined investor. Price and value often diverge.
3. A strategy of buying when prices are 33% to 50% below the calculated intrinsic value will produce superior returns in the long-run. The size of the gap between price and value is the “margin of safety.”
1st Evidence: Markets are not efficient. There is overwhelming evidence for periods going back to 1860, the markets are not efficient. Substantial evidence. 70% of professional investors under perform. It is so strong that it is almost disappointing.
The statistical approaches using value criteria automatically beat the market by 3%-5%. You must do better by reducing risk or concentrating.
Tweedy Brown: Stock Price as a Pct. of Book Value, 1967 – 1984 (from What Has Worked In Investing)
Over 8% difference in performance between lowest to highest price to BV!
Buy statistically cheap stocks and sell statistically expensive stocks.
If that does so well, why do they need you (professional money managers)? The big value firms have outperformed the market with lower variances.
2nd Evidence: Lazard and Oppenheimer beat the market with lower variances (less risk).
A disproportionately number of investors who have outperformed the market is similar to Warren Buffett. Note the investors from Graham and Doddesville.
From the Superinvestors from Graham and Doddesville:
A group of investors who year in and year out have beaten the record of the S&P 500.
225 million American coin-flip, each time the losers drop out. After 20 straights heads being flipped, there will be 215 Americans each having won $1 million. $225 million won and $225 million lost. Monkeys could do the same thing, but what if the monkey all came from a particular zoo in Omaha, Neb.?
The intellectual origin: A disproportionate number of successful coin-flippers in the investment world came from a very small intellectual village that could be called Graham-and-Doddesville. Their only focus is on two variables: price and value.
The investors were: Walter Schloss, Tom Knapp, Bill Ruane, Charlie Munger and Rick Guerin.
It is instant recognition–buying a dollar for 40 cents. What is the business worth?
This group assumed far less risk than average; note their record in years when the general market was weak. While they differ greatly in style, these investors are, mentally, always buying the business not buying the stock.
Risk vs. reward is negatively correlated.
The secret has been out for 50 years, ever since Ben Graham and Dave Dodd wrote Security Analysis, I have seen no trend toward value investing in the 35 years that I’ve practiced it. –Warren Buffet.
See full PDF below.