Is Value Investing dead?!
Dear Friends Many of you are probably familiar with the term value investing and see Warren Buffett as the poster boy for it.
But did you know that value investing started out very differently from Buffett's famous investments like See's Candies, Coca-Cola and American Express?
To know how value investing evolved, we have to start from its intellectual patriarch. Meet Benjamin Graham – the father of value investing.
When Graham first penned down his thoughts about investing in Security Analysis, the term 'value investing' wasn't even coined yet. But to Graham, he already had his own distinct ideas on how to differentiate a company's stock price and its intrinsic value.
Security Analysis's first edition was published in 1934 and America had just gone through one of the most severe economic recessions in the 20th Century – the Great Depression of 1929.
The stock market collapsed as well and there were many publicly listed companies that were worth more dead than alive. In other words, those companies were selling for less than their liquidation values. Graham's analysis was very much on the Balance Sheet – what those companies owned and owed. In fact, Graham ran his own very successful hedge fund, the Graham-Newman Corporation (which had annual returns of around 20% from 1936 to 1956), using a technique which relied extensively on Balance Sheet analysis. The technique was called Net-Net and it can actually be expressed in a simple formula: Net-Net = Current Assets – Total Liabilities Graham wanted to find stocks that were selling at two-thirds its Net-net value because he wanted a Margin of Safety. He knew that stocks selling at such depressed valuations were often in trouble in some way or another and so, wanted to use a very low buying price as a buffer in case things did not work out. To increase his odds of success, Graham also diversified widely, with some accounts saying he had more than 100 stocks in his portfolio at any one time. By diversification, he allowed the natural laws of statistics to play out with the stocks in his portfolio. Surely, such cheap stocks will rebound in price as people realised the folly of leaving a company worth more 'dead than alive', especially when they had minimal debt loads and were still making profits, Graham thought. Graham taught an investing course at Columbia Business School, which Warren Buffett attended. After Buffett's graduation from Columbia, he eventually ended up working for Graham at his investment firm, the Graham-Newman Corporation (GNC). People familiar with the term value investing in modern times might associate it with Warren Buffett and the analysis of a business's ability to generate above-average and sustainable profit margins and cash flows to determine intrinsic value with a focus on the Income and Cash Flow statement. Buffett wants to find compounders – companies that can grow intrinsic value over time. But, as we had shared in earlier posts, Buffett learnt about investing from his mentor Benjamin Graham, who is widely considered the intellectual patriarch of value investing. Graham invested very mechanically, and basically wanted to invest in a large basket of stocks that were selling at prices lower than their theoretically recoverable value should it be liquidated – these companies were essentially worth more dead than alive. And at the start of Buffett's professional investing career, that was indeed how he operated. That's a far cry from some of Buffett's well known investments in companies such as Gillette, American Express, Coca-Cola and See's Candies and what he preached about investing in his Berkshire Hathaway shareholder letters isn't it? So, what happened was Buffett came to know Philip Fisher and Charlie Munger and both of them were always on the look-out for the kinds of great businesses mentioned earlier. Buffett slowly adopted their methods into his own framework and became the investor he is today.
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