Are you new to Value Investing? This post is designed to help. Watch the short video where Steve Johnson describes the basics of value investing
Value Investing Overview
Value Investing is the method of investing practiced by Forager. It requires a business-like approach, an independent mindset and patience.
Share prices represent what it costs, at one point in time, to buy a tiny proportion of a company listed on the stock exchange – a company that employs people, produces goods or services and, hopefully, generates revenue, profit and cash flow.
Alongside this quoted stock price, value investors also take account of a company’s underlying, or ‘intrinsic’, value. Unlike the stock price, you can never get an exact fix on this figure but you can sometimes make a reasonable estimate by undertaking ‘fundamental analysis’. This involves looking at a company’s financial statements over time and making an assessment of its management, markets and growth potential.
Share prices vary enormously over the course of a year. But a business’s revenue, profit and cash flow rarely change anything like as much as its share price. The reason for this is that the price of a company’s shares is only a reflection of what people are willing to pay for them at any given time. Sometimes, usually when prices are rising, people are greedy. When prices fall, they become fearful and rush for the exits.
All this emotion can push the share price a long way from the intrinsic value of the underlying business. We aim to benefit from this by buying shares when they’re trading at significantly less than what we believe their intrinsic value to be.
The modern school of value investing was founded by Benjamin Graham, who, along with David Dodd, wrote Security Analysis and The Intelligent Investor. Graham’s approach was simple. He bought stocks that were trading at a significant discount to their liquidation value, which he calculated – conservatively – from the balance sheet.
Warren Buffett studied under Graham and embraced value investing with gusto. But he became less interested in Graham’s numbers-based approach. He wanted to know what really made one business better than another. Buffett soon realised it came down to those businesses with a strong ‘franchise’ and excellent management. Graham would buy any business if it was cheap enough; Buffett prefers to buy only quality businesses with excellent management.
Despite their different approaches, Graham and Buffett always assessed their investments in a business-like fashion, ensuring a considerable margin of safety in their purchases.
Why Value Investing Works
If value investing works so well, why doesn’t everyone do it? Because, whilst the concepts are easy to grasp, putting them into practice is hard.
Most investors view falling share prices as a bad thing, a signal that a company is failing in some way.
Successful value investors need to see through the negativity and put the opinions of the crowd to one side, looking at a situation with cool-eyed dispassion.
But because humans are hard-wired to follow the crowd, most can’t do that. Value investing works because most investors are not psychologically equipped to practice it.
That is why Forager’s loyal investors let us do the hard work for them. They get the benefits of an investment team naturally wired to buy when others are panicking and sell when the crowd is euphoric, and avoid the emotional trauma of trying to do everything themselves.
Foraging for Exciting Opportunities
As the Forager name suggests, our style of value investing involves scouring the world looking for unloved opportunities. Perhaps best described as a hybrid of the Graham and Buffett styles, we view both asset backing and earnings power as useful valuation tools, depending on the type of business we are investing in.
Like Buffett, we like buying high quality businesses if they are available at reasonable prices. But, like Graham, we also believe there is an appropriate price for everything. Buffett himself has said that he would invest very differently with smaller pools of money (his company, Berkshire Hathaway, has more than US$100bn in investments).
Our small size gives us the flexibility to do just that. If the potential returns are high enough, we have no qualms investing in mediocre businesses. And if the situation demands it, we are prepared to be activist in order to realise the value inherent in a company’s shares. Both approaches have worked well for us over the years and our aim is to stay.
Top 10 Books – our most recommended value investing reads
1. The Intelligent Investor by Benjamin Graham
2. Common Stocks and Uncommon Profits by Phil Fisher
3. One up on Wall Street by Peter Lynch
4. The Little Book that Beats the Market by Joel Greenblatt
5. Predictably Irrational by Dan Ariely
6. Thinking, Fast and Slow by Daniel Kahneman
7. Superforecasting: The Art and Science of Prediction by Philip Tetlock and Dan Gardner
8. The Great Crash 1929 by John Kenneth Galbraith
9. The Black Swan by Nassim Taleb
10. Security Analysis by Benjamin Graham and David Dodd
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