is anthat involves buyingsecuritiesthat appear underpriced by some form offundamental analysis.The various forms of value investing derive from the investment philosophy first taught byBenjamin GrahamandDavid DoddatColumbia Business Schoolin 1928, and subsequently developed in their 1934 text
The early value opportunities identified by Graham and Dodd included stock in public companies trading at discounts tobook valueortangible book value, those with highdividend yields, and those having lowprice-to-earning multiples, or lowprice-to-book ratios.
High-profile proponents of value investing, includingBerkshire HathawaychairmanWarren Buffett, have argued that the essence of value investing is buying stocks at less than theirintrinsic value.2The discount of the market price to the intrinsic value is what Benjamin Graham called themargin of safety. For the last 25 years, under the influence ofCharlie Munger, Buffett expanded the value investing concept with a focus on finding an outstanding company at a sensible price rather than generic companies at a bargain price.3
Graham never used the phrase, value investing the term was coined later to help describe his ideas and has resulted in significant misinterpretation of his principles, the foremost being that Graham simply recommended cheap stocks.
Other Columbia Business School Value Investors
Mutual Series and Franklin Templeton Disciples
Benjamin Graham(pictured) established value investing along with fellow professorDavid Dodd.
Value investing was established byBenjamin GrahamandDavid Dodd, both professors atColumbia Business Schooland teachers of many famous investors. In Grahams bookThe Intelligent Investor, he advocated the important concept ofmargin of safety first introduced inSecurity Analysis, a 1934 book he co-authored with David Dodd which calls for an approach to investing that is focused on purchasing equities at prices less than their intrinsic values. In terms of picking or screening stocks, he recommended purchasing firms which have steady profits, are trading at low prices to book value, have lowprice-to-earnings (P/E) ratios, and which have relatively low debt.4
However, the concept of value (as well as book value) has evolved significantly since the 1970s.Book valueis most useful in industries where most assets are tangible. Intangible assets such as patents, brands, orgoodwillare difficult to quantify, and may not survive the break-up of a company.5When an industry is going through fast technological advancements, the value of its assets is not easily estimated. Sometimes, the production power of an asset can be significantly reduced due to competitivedisruptive innovationand therefore its value can suffer permanent impairment. One good example of decreasing asset value is a personal computer. An example of where book value does not mean much is the service and retail sectors. One modern model of calculating value is thediscounted cash flowmodel (DCF), where the value of an asset is the sum of its futurecash flows, discounted back to the present.citation needed
Value investing has proven to be a successful investment strategy. There are several ways to evaluate the success. One way is to examine the performance of simple value strategies, such as buying lowPE ratiostocks, low price-to-cash-flow ratio stocks, or lowprice-to-book ratiostocks. Numerous academics have published studies investigating the effects of buying value stocks. These studies have consistently found that value stocks outperformgrowth stocksand the market as a whole.678
Simply examining the performance of the best known value investors would not be instructive, because investors do not become well known unless they are successful. This introduces aselection bias. A better way to investigate the performance of a group of value investors was suggested byWarren Buffett, in his May 17, 1984 speech that was published asThe Superinvestors of Graham-and-Doddsville. In this speech, Buffett examined the performance of those investors who worked at Graham-Newman Corporation and were thus most influenced by Benjamin Graham. Buffetts conclusion is identical to that of the academic research on simple value investing strategiesvalue investing is, on average, successful in the long run.
During about a 25-year period (196590), published research and articles in leading journals of the value ilk were few. Warren Buffett once commented, You couldnt advance in a finance department in this country unless you thought that the world was flat.9
Benjamin Graham is regarded by many to be the father of value investing. Along with David Dodd, he wroteSecurity Analysis, first published in 1934. The most lasting contribution of this book to the field of security analysis was to emphasize the quantifiable aspects of security analysis (such as the evaluations of earnings and book value) while minimizing the importance of more qualitative factors such as the quality of a companys management. Graham later wroteThe Intelligent Investor, a book that brought value investing to individual investors. Aside from Buffett, many of Grahams other students, such asWilliam J. RuaneIrving KahnWalter Schloss, andCharles Brandeswent on to become successful investors in their own right.
Irving Kahnwas one of Grahams teaching assistants at Columbia University in the 1930s. He was a close friend and confidant of Grahams for decades and made research contributions to Grahams textsSecurity Analysis,Storage and Stability,World Commodities and World CurrenciesandThe Intelligent Investor. Kahn was a partner at various finance firms until 1978 when he and his sons, Thomas Graham Kahn and Alan Kahn, started the value investing firm, Kahn Brothers & Company. Irving Kahn remained chairman of the firm until his death at age 109.10
Walter Schlosswas another Graham-and-Dodd disciple. Schloss never had a formal education. When he was 18, he started working as a runner on Wall Street. He then attended investment courses taught by Ben Graham at the New York Stock Exchange Institute, and eventually worked for Graham in the Graham-Newman Partnership. In 1955, he left Grahams company and set up his own investment firm, which he ran for nearly 50 years.11Walter Schloss was one of the investors Warren Buffett profiled in his famous Superinvestors of Graham-and-Doddsville article.
Christopher H. BrowneofTweedy, Brownewas well known for value investing. According to theWall Street Journal,Tweedy, Brownewas the favorite brokerage firm ofBenjamin Grahamduring his lifetime; also, theTweedy, BrowneValue Fund and Global Value Fund have both beat market averages since their inception in 1993.12In 2006,Christopher H. BrownewroteThe Little Book of Value Investingin order to teach ordinary investors how to value invest.13
Peter Cundillwas a well-known Canadian value investor who followed the Graham teachings. His flagship Cundill Value Fund allowed Canadian investors access to fund management according to the strict principles of Graham and Dodd.14Warren Buffett had indicated that Cundill had the credentials hes looking for in a chief investment officer.15
Grahams most famous student, however, is Warren Buffett, who ran successful investing partnerships before closing them in 1969 to focus on runningBerkshire Hathaway. Buffett was a strong advocate of Grahams approach and strongly credits his success back to his teachings. Another disciple,Charlie Munger, who joined Buffett at Berkshire Hathaway in the 1970s and has since worked as Vice Chairman of the company, followed Grahams basic approach of buying assets below intrinsic value, but focused on companies with robust qualitative qualities, even if they werent statistically cheap. This approach by Munger gradually influenced Buffett by reducing his emphasis on quantitatively cheap assets, and instead encouraged him to look for long-term sustainable competitive advantages in companies, even if they werent quantitatively cheap relative to intrinsic value. Buffett is often quoted saying, Its better to buy a great company at a fair price, than a fair company at a great price.16
Columbia Business School has played a significant role in shaping the principles of theValue Investor, with professors and students making their mark on history and on each other. Ben Grahams book,The Intelligent Investor, was Warren Buffetts bible and he referred to it as the greatest book on investing ever written. A young Warren Buffett studied under Ben Graham, took his course and worked for his small investment firm, Graham Newman, from 1954 to 1956. Twenty years after Ben Graham, Roger Murray arrived and taught value investing to a young student namedMario Gabelli. About a decade or so later,Bruce Greenwaldarrived and produced his own protgs, including Paul Sonkinjust as Ben Graham had Buffett as a protg, and Roger Murray had Gabelli.
Mutual Serieshas a well-known reputation of producing top value managers and analysts in this modern era. This tradition stems from two individuals:Max Heine, founder of the well regarded value investment firm Mutual Shares fund in 1949 and his protg legendary value investorMichael F. Price. Mutual Series was sold toFranklin Templeton Investmentsin 1996. The disciples of Heine and Price quietly practice value investing at some of the most successful investment firms in the country.Franklin Templeton Investmentstakes its name from SirJohn Templeton, another contrarian value oriented investor.
Seth Klarman, a Mutual Series alum, is the founder and president ofThe Baupost Group, a Boston-based private investment partnership, and author ofMargin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which since has become a value investing classic. Now out of print,Margin of Safetyhas sold on Amazon for $1,200 and eBay for $2,000.17
Laurence Tisch, who led Loews Corporation with his brother, Robert Tisch, for more than half a century, also embraced value investing. Shortly after his death in 2003 at age 80, Fortune wrote, Larry Tisch was the ultimate value investor. He was a brilliant contrarian: He saw value where other investors didnt — and he was usually right. By 2012, Loews Corporation, which continues to follow the principles of value investing, had revenues of $14.6 billion and assets of more than $75 billion.18
Michael Larsonis the Chief Investment Officer ofCascade Investment, which is the investment vehicle for theBill & Melinda Gates Foundationand the Gates personal fortune. Cascade is a diversified investment shop established in 1994 by Gates and Larson. Larson graduated fromClaremont McKenna Collegein 1980 and theBooth School of Businessat theUniversity of Chicagoin 1981. Larson is a well known value investor but his specific investment and diversification strategies are not known. Larson has consistently outperformed the market since the establishment of Cascade and has rivaled or outperformedBerkshire Hathaways returns as well as other funds based on the value investing strategy.
Martin J. Whitmanis another well-regarded value investor. His approach is called safe-and-cheap, which was hitherto referred to as financial-integrity approach. Martin Whitman focuses on acquiring common shares of companies with extremely strong financial position at a price reflecting meaningful discount to the estimated NAV of the company concerned. Whitman believes it is ill-advised for investors to pay much attention to the trend of macro-factors (like employment, movement of interest rate, GDP, etc.) because they are not as important and attempts to predict their movement are almost always futile. Whitmans letters to shareholders of his Third Avenue Value Fund (TAVF) are considered valuable resources for investors to pirate good ideas byJoel Greenblattin his book on special-situation investmentYou Can Be a Stock Market Genius.19
Joel Greenblattachieved annual returns at the hedge fund Gotham Capital of over 50% per year for 10 years from 1985 to 1995 before closing the fund and returning his investors money. He is known for investing in special situations such as spin-offs, mergers, and divestitures.
Charles de VaulxandJean-Marie Eveillardare well known global value managers. For a time, these two were paired up at the First Eagle Funds, compiling an enviable track record of risk-adjusted outperformance. For example, Morningstar designated them the 2001 International Stock Manager of the Year and de Vaulx earned second place from Morningstar for 2006. Eveillard is known for his Bloomberg appearances where he insists that securities investors never use margin or leverage. The point made is that margin should be considered the anathema of value investing, since a negative price move could prematurely force a sale. In contrast, a value investor must be able and willing to be patient for the rest of the market to recognize and correct whatever pricing issue created the momentary value. Eveillard correctly labels the use of margin or leverage asspeculation, the opposite of value investing.
Other notable value investors include:Mason HawkinsWhitney Tilson,20Mohnish PabraiLi LuGuy Spier21and Tom Gayner who manages the investment portfolio ofMarkelInsurance.
Value stocks do not always beatgrowth stocks, as demonstrated in the late 1990s.22Moreover, when value stocks perform well, it may not mean that the market isinefficient, though it may imply that value stocks are simply riskier and thus require greater returns.22. Furthermore, Foye and Mramor (2016) find that country-specific factors have a strong influence on measures of value (such as the book-to-market ratio) this leads them to conclude that the reasons why value stocks outperform are country-specific.23
An issue with buying shares in abear marketis that despite appearing undervalued at one time, prices can still drop along with the market.24Conversely, an issue with not buying shares in a bull market is that despite appearing overvalued at one time, prices can still rise along with the market.
Also, one of the biggest criticisms of price centric value investing is that an emphasis on low prices (and recently depressed prices) regularly misleads retail investors; because fundamentally low (and recently depressed) prices often represent a fundamentally sound difference (or change) in a companys relative financial health. To that end,Warren Buffetthas regularly emphasized that its far better to buy a wonderful company at a fair price, than to buy a fair company at a wonderful price.
In 2002,Stanfordaccounting professorJoseph Piotroskideveloped theF-Score, which discriminates higher potential members within a class of value candidates.25The F-Score aims to discover additional value from signals in a firms series of annual financial statements, after initial screening of static measures like book-to-market value. The F-Score formula inputs financial statements and awards points for meeting predetermined criteria. Piotroski retrospectively analyzed a class of high book-to-market stocks in the period 1976-1996, and demonstrated that high F-Score selections increased returns by 7.5% annually versus the class as a whole. TheAmerican Association of Individual Investorsexamined 56 screening methods in a retrospective analysis of the financial crisis of 2008, and found that only F-Score produced positive results.26
Another issue is the method of calculating the intrinsic value. Some analysts believe that two investors can analyze the same information and reach different conclusions regarding the intrinsic value of the company, and that there is no systematic or standard way to value a stock.27not in citation givenIn other words, a value investing strategy can only be considered successful if it delivers excess returns after allowing for the risk involved, where risk may be defined in many different ways, including market risk, multi-factor models or idiosyncratic risk.28
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Conversely, an issue with not buying shares in abull marketis that despite appearing overvalued at one time, prices can still rise along with the market.When value investing Doesnt Work
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