What Value Investing Is, and Isn’t

Charlie Munger stated it quite clearly. “All intelligent investing is value investing — acquiring more than you are paying for.”

So, value investing equals intelligent investing.

Ask anyone who has a faintest idea about value investing, and the general view is that it is same as bottom fishing, or buying cheap stocks – those that are trading at low price to earnings (P/E) or low price to book value (P/BV).

But this is far from truth.

Value investing is much more than buying cheap stocks.

As Munger said, “You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.”

So while investing is about buying cheap stocks, value investing is about knowing clearly what you are buying.

Benjamin Graham, the father of value investing, stated in his book Security Analysis…

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

What this definition implies is that if you don’t have proper data and reasoning associated with an appropriate price tag (cheap stock), it isn’t value investing.

After all, everyone is looking to buy low and sell high. What is it that differentiates real value investors, who are actually quite rare, from all the others who trade in the stock market?

Value Investing is…difficult!
My experience suggests that a majority of new “value investors” are upset after one year, mad after two, and gone after three. 🙂

In fact, most investors aren’t cut out for value investing.

This is simply because value investing can get really painful, and human nature shrinks from pain.

Making money on cheap stocks – which is the goal of every value investor – is harder than it sounds and can take years to play out.

In fact, identifying a cheap stock and buying it is a relatively easier proposition. But value investing is difficult, and because…

• You need to have patience, and a lot of it
• You must be disciplined
• You must mind your behaviour
• You must know when to go against the crowd
• You must read a lot (annual reports, investing books etc.)

In all, value investing requires hard work. This is probably the reason you won’t find many value investors out there.

But whoever has had the patience to practice value investing in its real form, has done wonders for his stock portfolio.

How can you become a value investor?
In his 1992 letter to Berkshire Hathaway shareholders, Warren Buffett wrote…

“We think the very term ‘value investing’ is redundant. What is ‘investing’ if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).

“Whether appropriate or not, the term ‘value investing’ is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments.

“Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a ‘value’ purchase.”

So it’s the ‘process’ of picking up bargain stocks that value investing is all about.

You must know what you are getting into.