Value Investing Principles Anyone Can Apply Even In Uncertain Times

Date: January 25, 2017

US Federal Reserve fund rates, the UK wanting to break away from European Union (EU), the Reverse Bank of India (RBI) governor Raghuram Rajan to be the first to not serve a five-year term…

Amidst all these big news, did everyone forget that we’re actually in the middle of a Great Singapore Sale (GSS), which only ends in mid-August? Well, most investors might be too fixated on these “big” news and forget what is happening on home ground.

If you are a person who likes looking around for discounts, regardless whether it’s the GSS or any other sale, you have the characteristics of a value investor! Anyone can be a value investor, in fact.

Investing is a simple concept – you essentially put money into a financial asset (company, property, bond, etc.) with the expectation of getting a profit. However, it is never an easy task. What to invest in, how much should you invest, when should you sell? Let’s take a look at a short history of value investing to better understand how it all came about.

How Value Investing Started

The basis of value investing is very simple – buy and hold undervalued stocks of great companies because their prices would rise in the long-term. So there are essentially three key principles of value investing: undervalued stocks, great companies, and long-term.

Value investing was first established by Benjamin Graham, which most of us already know. Later, Graham refined the value investing concept with his colleague, David Dodd, at the Columbia Business School.

Graham came up with the idea that investing should be a lot safer, and introduced a very interesting and important concept – margin of safety. This was adopted by many successful investors of our time, including Warren Buffett.

Graham and Dodd went on to write a book Security Analysis, which was actually the first text that introduced the concept of margin of safety. This was their first book that explained their mistakes in investments earlier on during the Wall Street Crash of 1929.

Graham went on to write a book that popularised value investing among individual investors – The Intelligent Investor. This book touched many successful investors, of which the most famous one is Warren Buffett.

How Value Investing Changed Warren Buffett’s Life

Warren Buffett was very business-minded since a very tender age. He resold eggs and candies when he was still a kid and delivered 500,000 newspapers for a penny each during his teenage years.

One day, he chanced upon Graham’s The Intelligent Investor. After reading the book, it changed his life completely. Many of the concepts and principles that he learned from Graham’s book are the bedrock of his investment philosophy even today.

Later on in Buffett’s life, he met his long-time partner Charlie Munger, who is his Berkshire Hathaway’s vice chairman. While Graham’s value investing approach was good – picking up companies that are undervalued – Munger commented that why not go a step further and pick out only the great companies.

Buffett’s approach before Munger was to pick up cigarette puffs on the streets that were left with one last puff. After being partners with Munger, he started picking up great companies that could last decades and his wealth increased exponentially ever since.

In a way, without Munger, Buffett might not be as successful as he is today. Nevertheless, we have to give credit to Buffett for being able to adapt and modify Graham’s approach to fit his own investing style and strategy. Here are the principles that govern value investing in today’s context.

Principles of Value Investing We Can Apply Today

1. Undervalued stocks. The first and most important principle wrapped around the concept “margin of safety”. Graham believes that every company has an intrinsic value. However, stock prices don’t always reflect the intrinsic value of the company, be it higher or lower. Graham believes the further a stock’s price is below its intrinsic value, the greater the margin of safety. Of course, the challenge is finding out the true intrinsic value of the company.

2. Great companies. Buffett doesn’t just look at any company, he looks really great companies. Buffett is known for his ability to pick out companies that are managed very well. To Buffett, think of buying stocks as collecting pieces of a company. If you wouldn’t be happy to hold pieces of the company, don’t buy it. Also, if the stock of a great company is undervalued, the margin of safety becomes even wider, making your investment a whole lot sounder.

3. Long-term. If you are buying an undervalued stock of a great company but don’t hold it long enough, you are not maximising your profits. Most individual investors tend to underestimate the compounding effect of investments. Buffett was able to amass such a huge fortune because of his patience and time-frame for his investments. His holding time allowed his wonderful investments to compound into extremely profitable values.

Author: Cayden Chang, Founder of Value Investing Academy (VIA)