Posted by kcchongnz > 2013-09-09 08:30 | Report Abuse

Lesson 1: Why Value Investing Works, Stockpedia What is Value Investing? Value investing is extremely simple in theory, but tougher in practice. If you compare the price of a stock with a confident valuation of its true worth (intrinsic value) and find you can buy it at a considerable discount (margin of safety) then you may be onto a winner. But value investing is much harder than it looks for two reasons, firstly the real intrinsic value of a company can be tricky to calculate but also the practice of buying beaten down stocks also runs contrary to almost all human instincts. But it’s precisely these tendencies that lead to so many investors over-reacting, driving prices down so low that value stocks become so profitable in future. We will explore each of these key principles of value investing in detail, identify actionable shortcuts to finding bargain stocks and consider five different value investing strategies that have been developed by some of the world’s most successful investors. Value Investors can be broadly defined as fitting one of two distinct categories depending on how they tackle the job at hand – they are either ‘value hunters’ or ‘value farmers’. While hunters such as Warren Buffet focus on making large, highly focused bets on single stocks, whereas the farmers from Ben Graham to Joel Greenblatt take these value investing ideas and apply them in a broader portfolio fashion in order to ‘harvest’ value-based profits from the market in a systematic fashion. How Profitable is Value Investing? Benjamin Graham is widely regarded as the dean of value investing as well as the whole industry of Security Analysis. This influence stems not only from his published works but also from the eventual fame and fortune of the pupils that he taught at Columbia University who included Warren Buffet. It is thanks to Graham that we have a whole catalog of quantitative bargain stock strategies at our disposal with such obscure titles as ‘Net Net Bargains’ and ‘Net Current Asset Value Bargains’ as well as a whole ream of other concepts including Margin of Safety and Mr Market. In spite of being personally wiped out in the 1929 stock market crash, by the time the Graham-Newman partnership was closed it had delivered an average 17% annualized return to investors, outperforming the market by a considerable margin and making the elderly Graham an exceptionally wealthy man. But his pupils became even wealthier. In a paper titled 'The Super Investors of Graham and Doddsville' Warren Buffet showed the track records of each of nine disciples of Benjamin Graham showing that they all generated annual compound returns of between 18% and 29% over track records lasting between 14 to 30 years. Is it likely that these individuals from the same school of thought could all beat the market over a generation if the stock market was a place of luck? Warren Buffet doubted it most eloquently when he said “I'd be a bum on the street with a tin cup if the market was always efficient”. Lets have a look at their profit history... Investor No. of Yrs Annualised Return S&P / Dow Return Buffett Partnership 13 29.5% 7.4 % (Dow) Walter Schloss 28 21.3% 8.4% Tweedy Browne 16 20% 7% Bill Ruane 14 18.2% 10% Charlie Munger 14 19.8% 5.0% (Dow) Pacific Partners 18 32.9% 7.8% Perlmeter Investments 18 23% 7.0 % (Dow) Why does value investing work? The human mind is split between the 'human' frontal lobes and the 'primal' limbic brain. At times of stress or excitement we fall back on primal instincts which are ill suited to the Spock-like nature we need to cultivate for investment success. Behavioral science has shown that we suffer from a range of judgmental errors including overconfidence in our abilities, herd behavior, loss aversion and anchoring on irrelevant information which push share prices to extremes of highs and lows driven by hopes and fears, elation and despair. Until the day (god forbid!) that man and machine become one and these tendencies are ‘debugged’ from our habits, value opportunities and mispricings will continue to be available to in-the-know contrarian investors. Can't professionals do this for me? Unfortunately, despite the huge evidence that value strategies work, it is unlikely that a well thought-through value-based investing approach is being put to work for you and your family or anyone else that saves money in an actively managed fund. The extraordinary truth is that 75% of actively managed funds underperform their benchmark over the long term due to the cost of high and often under-disclosed fees. Individuals who do have the time and discipline to do their own research are generally going to be better off taking investing matters into their own hands. There are cheap, neglected, misjudged stocks out there and with the and with the right techniques up your sleeve it isn’t so hard to find them and profit from them.