We often talk about investing your way to wealth. We often talk about how you need an investing strategy, but seldom do we talk about how you can invest using it! One of the most famous investment philosophies is value investing, but what is it?
Buy Great Companies
Value investing was first set out by Benjamin Graham, in his book The Intelligent Investor. A book generally considered to be one of the best finance books ever written! In his book, Benjamin Graham set out how to buy a great company at a great price.
He said that you don’t have to buy index funds (such as the FTSE 100 or S&P 500) in order to beat the market. He also said that you don’t (or rather shouldn’t!) need a professional investment service (such as a financial planner) to help you do this.
That’s right… he said that you can do it… on your own!
He said that there were certain ‘tells’ from a company to tell you that they are a great company! Benjamin Graham sets out in The Intelligent Investor and in his other books, these various ‘tells’.
- Is management invested in the company?
- Are the founders (assuming they’re still alive) involved with the management?
- Is the CEO honest to shareholders? (Does he/she tell investors the good and the bad in the shareholder letter?)
- And more!
But these companies aren’t necessarily your global corporations…
The basics of value investing state that you are looking for a company that is undervalued by the market, but is financially sound. Essentially, buying a $10 bill for $5! Chances are, that a global corporation like McDonalds aren’t going to be undervalued!
Warren Buffett (the most famous value investor) until recently operated what he called a “Cigar Butt” investment strategy. That is to say, a company that’s not doing great, but still good for one last puff I suppose.
Whilst I wouldn’t recommend that you follow that investment strategy, it’s certainly possible!
Due to people’s apprehension of adopting Warren Buffett’s “Cigar Butt” philosophy, other philosophies have been introduced, including Rule One Investing. But that is a story for another day…
Buy at a great price
Alongside buying a great company, value investing also states that you should buy it at a great price! That is to say, when the market vastly undervalues a stock. This doesn’t happen often mind you, so you’ll probably want to know why a stock is undervalued!
Probably the most publicized reason why a company might be “on sale” so to speak. You only need to think of what stock prices in 2008/09 to see the truth in that!
(Roughly) every 5-10 years, there is a market crash, whether we like it or not. Every year, stock prices go up on average. But eventually, these prices just get too high, and no longer produce the returns that investors are looking for!
This is usually then catalyzed by a major corporate collapse, change in government policy or something similar! In 2008, the collapse of Lehman Brothers (a major investment bank in the US) was the catalyst for the Great Recession.
During recessions, for many different reasons, investors get fearful of further stock plummets. As such, they decide to cut their losses and pull out, flooding the market with more and more shares! This then causes the price to plummet even more!
So why not wait for this? Why not save as much money as possible and wait for the market crash to start investing in great companies, now at a great price!
A market correction is very similar to a market crash. However, instead of being catalyzed like what happens with a market crash, the price get lower and plateaus out. Thus correcting itself.
Sometimes the correction can last a matter of days, sometimes a matter of weeks, sometimes even a year! But one thing is sure: the media will be all over it. Outlets like Bloomberg, CNBC and the Wall Street Journal will be all reporting the correction!
As a result, these stocks are often on sale. If you got a list of great companies to buy into, a market correction will lower the price to the point where it is on sale and then you’ll be able to invest in it!
Corporations as *legally* people, and just like you and I, corporations make mistakes. Sometimes, these are minor errors that mean nothing in the grand scheme of things. But other times, this is absolutely devastating!
There are literally hundreds of examples where this has happened. Not just throughout history, but in recent years! Just think of Boeing with their 737 MAX, or the Equifax data breach in recent years…
But by far the most famous is when Chipotle inadvertently caused several cases of food poisoning. Naturally, for a fast food restaurant, this is something that they want to avoid at all costs- not only does it cause lawsuits from victims, but also loses consumer confidence too!
In 2016, when the LA Times reported that Chipotle had caused several cases of food poisoning, their stock plummeted. This led many value investors to jump at the opportunity to buy Chipotle stock, and ultimately make a LOT of money!
I have no affiliation with Chipotle, please do not go out buying Chipotle stock based on this story!
The Market misses something
Just because the market thinks something is irrelevant, it doesn’t necessarily mean so. So, if you think it is relevant, trust yourself! The market often misses things, so it’s your job to try to find that information!
Probably the most famous story about something like this is Sanborn Map Co. obviously, this company made maps, however, they were a highly specialized type of map only used by insurance companies! However, at the beginning of the 1960’s, this was becoming more and more irrelevant.
As such, they saw their income drop from $700,000 in 1951 to only $300,000 in 1958.
In 1958, Warren Buffett was researching various companies he could invest in, when he came across Sanborn. What he found, caused him to invest 30% of his firm’s assets into Sanborn- a company with no discernible income to speak of!
He had found that over the past few years, Sanborn had been using its revenue very wisely. Instead of using the revenue to buy back stock or give investors a special dividend, they invested the money.
According to their market capitalization, the company was worth $4.7 million. According to their financials, they had a portfolio worth $2.5 million. But what Warren found was that the $2.5 million figure was only cost, not total value.
When he looked at the total value, it was $7.2 million! As such, Buffett bought the majority stake in the company, and promptly liquidated it. Thus, getting a massive return on his investment!
Having a “Moat”
Value investing also talks about a “Having a “Moat””. That is to say, that besides the company being at a great price and being great all around, there should be something else. Something that separates that company from its competitors.
There are many reasons you may want to have a “Moat”. But by far, the most prominent reason would be: security.
After all, this is something that makes it different from its competitors! This is a reason why you go to that company and not another! A “Moat” could be:
- A patent for a particular thing
- A loyal customer base
- Strong brand imaging
- Better technology
- Better buying power
- Higher output
Have you ever tried value investing? Tell me in the comments!