What Does Value Investing REALLY mean?

What Does Value Investing REALLY mean?

By Sid el Mehdi Lembirik, Managing Partner, Lembirik Group
“Value investing” is one of the most overused and misunderstood terms in the investment business. The long-term success of true value investors such as Warren Buffett, Charlie Munger, Walter Schloss, Bill Ruane,, … enticed many charlatans to label themselves value investors in order to attract assets to manage. Value investing is used as a marketing tool instead of an investment philosophy, there are even day traders who call themselves value investors!

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Many have little or nothing to do with the philosophy of investing originally introduced by Benjamin Graham. Academics define value investing as buying securities with the lowest price to earnings ratio (PE) while growth investing as buying securities with the highest PE. The problem with this approach is that a security can have a high PE (growth stock according to conventional wisdom) when earnings are not growing at all or dropping. PE ratio by itself is no indication of how cheap a stock is, as it can be distorted by a one-time gain or loss in earnings.

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The cornerstone of value investing is not about low multiples, but rather, it’s about the concept of margin of safety as Benjamin Graham noted in his book The Intelligent Investor. “Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety”.

When it comes to any purchase we make, it can be a piece of furniture, clothing or a stock we want to pay for less than the asking price. That difference between the price tag and the price we buy at is the margin of safety. It protects the investor from errors of calculations and serves as a buffer in avoiding permanent capital loss. After all, value investing is about limiting capital loss versus striving for spectacular gains.

Warren Buffett explains it this way “You don’t try to buy businesses worth $83 million for $80 million. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And that same principle works in investing”.

To be a value investor, one has to think long-term, be disciplined, understands the wisdom of a value approach and always seek a margin of safety. Unfortunately, these value pretenders violate all these principles by overpaying for securities, following the herd mentality while engaging in a short-term approach.

Yet, during bull markets, as we are witnessing now, the rising tide lifts most ships. Most investment strategies seem profitable and mistakes are not costly. Investors succumb to euphoria. This is the time when undervalued securities get scarce causing people to question the soundness of value investing, labeling it as “dead”.

The true test of an investment philosophy is during a market downturn. Securities that have performed well in a bull market are usually those for which investors have had the highest expectations. When these expectations are not met, the securities, which typically have no margin of safety, can plummet. As Warren Buffett said, “Only when the tide goes out, you discover who’s been swimming naked”.

By Sid el Mehdi Lembirik, Managing Partner, Lembirik Group

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