Back To Basics: Valuing A Cow; Value Investing Principles

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Basics about value investing.


Buffett says there are ONLY two things you need to know as an investor

  1. How to think about prices (Read Chapter 8 in The Intelligent Investor by Ben Graham).
  2. How to do valuation: See below

Tevye W as a Rich Man – The Quintessential Value Investor

I’D LIKE TO INTRODUCE YOU TO MY HERO, Tevye the Milkman. Didn’t read about him in your investing books? Tevye came to life in the stories of Shalom Aleichem, and later to the silver screen in the musical Fiddler on the Roof .

Tevye is my hero not just because he is a font of worldly wisdom, or because he can sing, or because he is a great and kind father, or because he romances the memories of my ancestors. I honor Tevye because he is a pragmatic value investor .


Tevye lives in a small village in eastern Europe; he is a farmer and a milkman. He may not be familiar with the maxim that the value of any asset is the present value of the asset’s future cash flows, but that doesn’t prevent him from applying these principles.

Tevye’s story highlights what value investing is all about: analyzing an asset be it a cow, a stock, or a bond by assessing its risk; valuing it or figuring out what it is worth; and calculating a suitable purchase price. If an asset trades at the desired price or below it, you buy it; if not, you wait patiently until it gets to your target price.

That’s it!

Unfortunately, market noise often deflects us off this simple path, but it really is that simple. I often think about Tevye to keep my focus amid the daily noise.

Meet Our Hero

Tevye needs to buy a young cow. He plans to name her Golde, after his first wife. Based on his previous experience, he expects Golde to produce about 2,500 gallons of milk a year, bringing him about $3,000 in revenues a year. After paying for a barn, high – quality feed, stud fees, top – notch veterinary services, his otherwise unemployed nephew to take care of and milk Golde, and finally, taxes, he expects to pocket about $1,000 a year from the milk


Value Investing

See the full PDF below.

Then place those two skills in an investing philosophy/framework. See below.

Manifesto On Value Investing

Part 1: Introduction

The relationship between a client and a money manager is like a marriage: even if you’re married to the right person, it’s just a matter of time before your relationship will hit hard times that test the strength of your marriage. After all, life is not linear, it’s full of ups and downs. The downs will ultimately test a couple’s commitment to one another.

Just like life, stock returns are anything but linear. Over the last one hundred-plus years, stocks returned about 11% a year on average. But if you were to look at stock market returns on an annual basis, they were usually anything but 11%. This 11% average is the culmination of a very combustible mixture of numbers that individually bear very little resemblance to the average they result in.

Side effects of nonlinearity of stock behavior clearly show up in investor returns. The financial services market research firm DALBAR studied historical returns of mutual funds and actual (realized) returns of investors who invested in those mutual funds. DALBAR’s findings were stunning. For decades fund investors had significantly underperformed the mutual funds they invested in, not by a percent or two but by a mile, capturing only a small fraction of the returns of those mutual funds.

For a civilian (nonprofessional) investor, understanding the investment process of a fund manager is usually difficult. Often, performance is the only thing investors can judge objectively, so recent performance overshadows all other metrics. Investors compare the most recent returns of their favorite new mutual fund versus the returns of the one they’re holding. If the new mutual fund has done better recently, they’ll sell the old one and buy the new one. This often results in buying high and selling low.

Any money manager, whether he is managing separate accounts or a mutual fund, will go through stretches where he looks smarter or dumber than he really is, though his IQ hasn’t actually changed.
When we look smarter than we are, we’re not worried about what clients think of us (though we try to temper their expectations of our future brilliance). At that point our biggest concern is our own self-perception: we don’t want success to go to our heads and result in overconfidence.

On the flip side, it’s just a matter of time before we look dumber than we are, and that’s when our relationship with a client gets tested. Especially if it’s a very new relationship and the client hasn’t had a chance to experience our brilliance.

Historically, value investing (owning undervalued companies) has done significantly better than other strategies. Paradoxically, the reason it has done well in the long run is because it did not work consistently in the short run. If something works consistently (key word), everybody piles into it and it stops working.

These aforementioned cycles of temporary brilliance and dumbness are not just common to us mere mortals. Even Warren Buffett’s Berkshire Hathaway goes through them. As just one example, in 1999, when the stock market went up 21% Berkshire Hathaway stock declined 19%. In 1999 the financial press was writing obituaries for Buffett’s investment prowess.

See the full PDF below.

Study up for the several valuation case studies to follow this week.


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