What is Value Investing?
According to Forbes, Warren Buffett made the biggest gain in wealth during 2016, a staggering $12 billion increase to reach over $74 billion. Buffett is the second wealthiest person in the world, behind his good friend Bill Gates who has over $84 billion.
Buffett made his huge fortune through shrewd investing over many years and, of course, many people try to copy his ideas and philosophy. We are certainly not going to try and teach you to be another Warren Buffett in this short article, but you should know that he is an expert “Value Investor”. He learned his trade from the father of value investing, Benjamin Graham, who was Buffett’s teacher at Columbia Business School.
So what is “value investing”? Well, simply said, it is buying financial instruments such as shares and bonds at bargain prices, that are less that the intrinsic values of the shares or bonds. It’s about paying less than true value of the share or bond and waiting for the price to increase until it reaches that true value. Well that sounds easy doesn’t it? Just like buying anything else in life, we all like to buy something cheaply or on sale. The concept is quite simple but it’s certainly not easy to implement, and even Mr Buffett has made some big mistakes, as he will readily admit.
The first problem is that share and bond prices usually fall because they are out of favour in the market, that means to buy them you will need to go against the opinion of the market. Human beings typically don’t like to do something very different to everybody else!
How do you decide that the real value is much higher than the current price? There are multiple ways to value stocks and bonds, but the basic idea is that you calculate future returns, relating that to the existing price and what the price actually should be. Buffett has never revealed how he values shares and bonds but he has said that it is not complicated, he doesn’t need to use any computer program to do so.
Patience is the next requirement for value investing. Shares and bonds that have lower prices than their true (intrinsic) value may take years to recover, meanwhile prices might fall much lower or even crash completely! Few people have the patience and mental resolve to sit and wait for the recovery, being especially tempted to sell when values fall further.
Finally, when the price does rise, when do you sell? Buffett rarely sells but if you are sitting on a 50% gain it might be very tempting to sell, taking the profit there and then! However the ideal time to sell will be when the price reaches, or goes above, the intrinsic value that you calculated when you first bought the share or bond. Of course, during the time you have held the shares or bonds, there may well have been developments that increase or decrease the real value, so that also needs to be considered during your selling decision.
If you want to learn more about value investing you could start by reading “The Intelligent Investor”, written by Benjamin Graham in 1949. According to Warren Buffett it is still the best book ever written on investing!
Value investing is certainly not for everybody, even if it has been used by Warren Buffett to make him hugely wealthy. There are numerous kinds of other investment styles including growth, momentum, small companies, income, etc. We strongly believe that following a particular investment strategy or philosophy is a deeply personal matter, which depends on a persons own situation, attitude to risk and future plans.
At our company Austen Morris Associates, we first talk to our clients, we have an open comprehensive conversation, this is to fully understand which investment style will be most suitable for them. We certainly don’t adopt a “one size fits all” philosophy!
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