Value investing is a strategy advocating the purchase of stocks that are underappreciated by other investors or the broader market. Value investing was popularised by investor Warren Buffett, but the approach was pioneered by Benjamin Graham and David Dodd at Columbia Business School in the early 1920s. Graham would later go on to release the seminal book The Intelligent Investor in 1949.
Understanding value investing
Buffett himself became a student of Graham’s and was later employed by him at the investment firm Graham-Newman Corporation.
In one of his many interviews, Buffett had this to say about value investing:
“The basic ideas of investing are to look at stocks as business, use the market’s fluctuations to your advantage, and seek a margin of safety. That’s what Ben Graham taught us. A hundred years from now they will still be the cornerstones of investing.”
Value investing is based on the central premise that every stock has an intrinsic value. Investors can analyze a company’s fundamentals and then purchase stock if they believe it is undervalued.
Over time, most stocks realize their intrinsic value and the value investor makes a profit in the process.
The four pillars of value investing
Benjamin Graham suggests four components explain the somewhat philosophical approach behind value investing.
These pillars are:
The value investor should imagine they are in a business relationship with Mr. Market, who offers higher prices in an optimistic mood and lower prices in a pessimistic mood.
The time to purchase value stocks is when Mr. Market is in a pessimistic mood.
We touched on intrinsic value earlier, which Graham defined as the “true” value of a company based on its financials.
However, it’s important to note that modern value investors also consider qualitative factors such as industry dynamics, competition, and consumer behavior.
Margin of safety
The margin of safety gives value investors a buffer if their value estimations are overly optimistic.
To that end, Graham suggested investors “buy stocks the way you buy groceries, not perfume”.
Investors must know the difference between price and value and purchase stocks that are on sale, so to speak.
Value investing is a long-term strategy and is not concerned with what a stock price is doing in 3 days or 3 months from the time of purchase.
Instead, it seeks to identify stocks that will outperform the market over a horizon measured in years.
Other notable value investors
It would be remiss of us not to mention some of the other well-known proponents of value investing. The approach has served as inspiration for such investors as:
The long-time business partner and friend of Buffett who some consider to be his right-hand man.
Munger is still value investing at the age of 98 and recently noted in an interview with the Australian Financial Review that “I’m still looking for more value than I pay for.”
An American hedge fund manager, investor, and writer who also taught MBA students at Columbia University’s Graduate School of Business.
Greenblatt is the author of the value investing book The Little Book That Still Beats the Market.
An Indian-American businessman, philanthropist, and author.
Pabrai is a self-confessed Buffet-imitator and once paid more than $650,000 to have lunch with the man.
His firm Pabrai Investment Funds managed $636.8 million in assets according to an April 2021 SEC report.
- Value investing is a strategy advocating the purchase of stocks that are underappreciated by other investors or the broader market.
- According to Benjamin Graham, value investing has four pillars: Mr. Market, intrinsic value, a margin of safety, and a long-term investment horizon.
- Some of the most notable value investors include Charlie Munger, Joel Greenblatt, and Mohnish Pabrai.
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