What is value investing?
SIT BACK, RELAX,
AND ENJOY THE FLIGHT
Value Investing is just like taking a plane from Amsterdam to New York. Before selecting a flight, one will probably conduct research to find the right flight in terms of price, duration, and quality. You know in advance that the flight will take a while. You also know the destination (goal) and you are confident that you will reach your destination (goal). There might be turbulence along the way but it part of the journey. The same holds true for value investing. You conduct your research to make the best investment selection. Thanks to your research you are now confident of the future. There might be unfavorable developments on a macro or micro level that will rock the share price, but you hold steady. You are focused on the prize.
HISTORY
Value investing was invented in the 1920s by Benjamin Graham and David Dodd and was later popularized by Warren Buffett. This technique means that you purchase shares that are undervalued on the market. In other words, the stock is selling for (far) less than its worth. It becomes very cost effective to purchase these shares and to later sell them at their true value. In 1934, Benjamin Graham and David Dodd published the book Securities Analysis, which is considered the most important book for investors. This book makes a distinction between investing and speculating.
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In 1949, Ben Graham published The Intelligent Investor in which he describes the important concept of Margin of Safety and introduced Mr. Market. Mr. Market symbolizes the inefficient marker hypothesis. There is a real difference in how stock markets are approached. Speculation is used to achieve a profit within the shortest possible time. Luck plays a very large role when it comes to speculation. Value investing on the other hand has the primary goal of preserving capital. This means that the investment approach leans more towards probabilities. Nothing is risk-free, but with a proper risk-reward ratio one keeps the risk low while ensuring good earnings potential.
EMOTIONS
Emotions (Behavioral finance) plays an important role in investments. A lot of people allow themselves to be misled by market signals or any other news. People like to go with the herd. If everyone is selling, they sell. If everyone is buying, they buy. Value investing is the exact opposite. Value investors are contrarian investors in the sense that they move against the herd. They buy when others are selling and sell when others are buying. In other words, value investors are not led by emotions but makes use of the irrational (emotional) decisions of the general market. A great example is the early stages of the COVID-19 pandemic. The general market was fearful and started a sell-off. Contrarian investors increased their investments as the prices were falling. Although the former may have recovered their losses, the latter likely made a huge profit.
It boils down to buying valuable companies at discounted prices. While emotional selling or buying directly affects a company’s price, it does not affect its value. As the discount becomes steeper the more we would like to buy in other markets like housing, auto, and other products & services. Why should we do it differently for stocks? By buying valuable companies at discounted prices, we limit our downside risk. In essence, we are securing our profit at the time of purchase.
WHAT DO WE
INVEST IN?
We do not merely look for companies trading at discounted prices. We look for companies with products and services that are the backbone of the economy. Companies that are able to sustain sales and profits no matter the economic cycles. In addition to these we look for companies with high quality management teams, solid balance sheets, real underlying assets, projectable free cash flows, competitive advantages to name a few. Companies are thoroughly researched and valued by our team to determine the discount rate.
WARREN BUFFETT
& BERKSHIRE HATHAWAY
Warren Buffett is one of the most renowned investors in the world and is known for his value investing approach. Value investing was invented in the 1920s by Benjamin Graham and David Dodd and was later popularized by Warren Buffett. This technique means that you purchase shares that are undervalued on the market. In other words, the stock is selling for (far) less than its worth. It becomes very cost effective to purchase these shares and to later sell them at their true value.
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Warren Buffett is the general director of Berkshire Hathaway, an investment conglomerate that holds shares of other publicly traded companies and own some companies out right. Buffett is known for his down to earth way of doing business. The key to his success is the way in which he selects the companies. Buffett has an excellent insight into companies. He naturally applies certain criteria and in addition he has very good business instincts.
Buffett’s investment strategy enabled him to consistently beat the Standard & Poor's 500 (S&P500) by an annual average of twice the rate (10% vs 20%). The S&P500 index provides a reliable image of the developments in the United States stock exchange markets. Buffett’s initial goal was a compound annual growth rate of 15%. It is clear that he exceeded his goal by far. The result is even more impressive if you consider the fact that these are results after tax. The income tax and levies on the achieved increase have been deducted, while the S&P 500 does not take the tax into account.
THE BIOGRAPHY OF
WARREN BUFFETT
Warren Buffett was born in Omaha, Nebraska in the United States on 30 August 1930. His parents were Howard and Leila Buffett. His father Howard was a local stockbroker and representative for the Republican Party. Buffett loved doing numbers even as a child and was excellent at mental arithmetic. At age six he started selling cans of coke in the street. He would purchase 6 cans of coke for 25 cent and sell them for 5 cent a piece. In doing so, he achieved a 16% profit. At the age of eight, he started reading his father's books on the stock exchange. He also purchased his first shares: Cities Service Preferred.
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He was living in Washington DC because his father was a representative there. This is where Buffett became a businessman. At the age of 13, he was doing two paper rounds. He delivered both the Washington Post and the Times-Herald. He used the money he earned, approximately 175 dollars a week, to purchase secondhand pinball machines for 25 dollars which he placed in hair salons. These pinball machines generated a weekly income of 50 dollars. A year later he purchased a Rolls Royce, year of manufacture 1934, for 350 dollar and leased it for 35 dollars a day. In short, when Buffett obtained his high school diploma at the age of 16, he had already been able to save $6000.
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The book, The Intelligent Investor by Benjamin Graham, has had a great impact on Buffett's work. He read this in his final year at the Wharton Business School in Nebraska. When he obtained his diploma, he left for New York to attend lessons given by Benjamin Graham at Columbia Business School. Graham had a mathematical approach when it came to investing which strongly appealed to Buffett. When Buffett obtained his MBA diploma, he returned to Omaha to work in his father's brokerage office. He stayed in touch with Graham to discuss investment ideas. In 1954 Graham asked Buffett if he was interested in moving to New Work to work for the Graham-Newman Corporation. This way he could experience Graham's strategy and philosophy in action every day. However, there were a lot of frustrations for Buffett within the company as he had a lot of ideas of his own which were not valued. This led to the end of the partnership in 1956. Graham, 61 at the time, decided to retire. Buffett returned to Omaha, having gained a lot more experience. By then he was 25 years old and was able to incorporate an investment company with the financial support of family and friends.
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This investment company consisted of seven partners who put in a total sum of $105,000. Buffett was the chairman and invested $100. The partners received an annual interest of 7% plus the 75% of the profit achieved by the company. The remaining 25% would go to Buffett. In the 13 years that followed an average annual profit of 29.5% was achieved. The Dow Jones index closed lower than it had been in January in five of the 13 years; Buffett clearly did well. He realized a profit every year. He promised his partners 'only to invest based on the value of a share and not on the basis of its popularity'. He said that 'he tried to limit a possible capital loss to a minimum, although a temporary decline in the exchange rate would not be that great that it merits a panic response and a sale at a loss'.
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Buffett didn't always hold minority positions in companies, but also held majority interests and bought companies out right. In 1961 he purchased Dempster Mill Manufacturing Company, a company that manufactured agricultural tools. The year after he purchased shares from a textile company, Berkshire Hathaway. Buffett's reputation improved and more and more people asked him to invest their money with him. This resulted in more shareholders and lead to the incorporation of an increasing number of investment companies. In 1962, there was a reorganization, and Buffett merged them all into one company. The office was first at his private home address, but then moved to the current address, Kiewit Plaza in Omaha. The assets of the company had increased in 1965 to 26 million dollars.
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Some shareholders invested in Berkshire Hathaway (the textile company) along with Buffett. Buffett's share amounted to 25 million dollars, which was sufficient to have full control over Berkshire. In the next couple of years, the wealth of Buffett and Berkshire Hathaway grew exponentially. Still Buffett aimed to make Berkshire profitable without heavy capital injections. In the early 1980's, it became clear that achieving high returns on investment in the textile sector was simply impossible. Foreign competitors had cheaper labor. In order to be able to compete, more capital injections were needed. There was high inflation at that time, so not a pretty prospect. Particularly as everyone knew that the return on investment could continue to be low.
In July 1985 Buffett dissolved Berkshire Hathaway the textile company. Still, Buffett said there was an important lesson to be learned from this story: Turnarounds seldom succeed. Despite everything, Berkshire Hathaway had generated sufficient funds for Buffet's investment fund (that continued under the name of Berkshire Hathaway fund) in earlier years to purchase an insurance company.
The rest is history.