What is Value Investing?

December 14, 2015

 

While Benjamin Graham established the more modern version of value investing, value investing has been around for quite awhile.  Value investing is simply buying something at a price that is less than what it’s worth.  This can occur regardless of whether market prices are high or low – there are always companies trading at discounted prices.

 

Value investing can be found in everything you do: buying that big screen TV from Best Buy at a discounted price during the Christmas season, buying an old-model Mustang and fixing it up to sell at a much higher price than what you bought it for, or buying a foreclosed house.  It can literally be seen in every aspect of your life.  People look for discounts for one simple reason: they believe the product they are buying is not worth full market price. Investing in a business’ stock, in our opinion, is no different.

 

The general public is aware of value investing nowadays thanks to the likes of Warren Buffett, Charlie Munger, or Bill Ackman, to name a few.  There are a couple key tenets to value investing:

 

  1. A stock is a piece of a business, and not a piece of paper to be traded on a high-frequency basis.
     

  2. Intrinsic value – what one believes the company to be worth.
     

  3. Margin of Safety – the difference between the market price and intrinsic value.  Having a margin of safety helps the investor allow for any mistakes they have made in their calculations of intrinsic value.  This buffer, if you will, helps protect an investor by limiting the downside.

 

Let me give you an example.  Company X is a publicly traded company that sells specially designed screws to airplane manufacturers.  Its shares trade for $10/share, and your local value investor thinks it’s worth $20/share.  This would be a great buy because the investor’s margin of safety is 50% ([$20 - $10]/$20).  Over time, the market will recognize Company X’s value, and its price will gradually gravitate to that point.  The value investor should take note of Warren Buffett’s statement found in the 1993 Berkshire Hathaway Shareholder Letter:

 

“As Ben Graham said: 'In the short-run, the market is a voting machine - reflecting a voter-registration test that requires only money, not intelligence or emotional stability - but in the long-run, the market is a weighing machine.’”[1]

 

Buffett’s point is simple: in the short-run, investors will always react with stupidity and emotion, but in the long-run, the markets will gradually recognize securities' intrinsic values.  We are in it for the long-run, and will strive to invest with a margin of safety so that our clients’ holdings’ intrinsic values will be recognized.

 

Sincerely,

 

LBW

 

[1] Berkshire Hathaway. Annual Report: 1993 Annual Report. Omaha: Berkshire Hathaway, 1993.

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