Have you heard of value investing? Perhaps you want to be a value investor with the likes of Warren Buffett and Benjamin Graham. If you do, you’re in the right place. You see, Benjamin Graham wrote a book called The Intelligent Investor. Buffett believes it to be the top foundational book on investing.
I just created a list of the top 75 books on personal finance and The Intelligent Investor is the first investing book I mention.
It’s a great book. You should really read it, but if you’ve been too
lazy busy to read it, that’s ok, because I’ve put together a summary for you. I’ve outlined what I believe to be the 5 key principles of value investing: analysis, safety, awareness, discipline and return. I’ve packed in some (but not all) of the best quotes from Benjamin Graham himself and organized it just for you!
Unless otherwise noted, every quote is taken from The Intelligent Investor by Benjamin Graham.
Here’s your guide to value investing…
“To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street. “
If you want to be a value investor, you should be analyzing the company, not the news about the company.
“It is absurd to think that the general public can ever make money out of market forecasts.”
There is a ridiculous amount of hype in the financial media. If you want to be a value investor you have to ignore basically everything they say. Here are a few examples of what to ignore:
- Market news
- Market forecasts
- Market debates
- Stock predictions
- Buy/sell advice
- Any “hot stock” tips
“A great company is not a great investment if you pay too much for the stock…Although there are good and bad companies, there is no such thing as a good stock; there are only good stock prices, which come and go.”
Even the best companies can have overpriced stocks. Remember that. But that’s ok, because there are plenty of value stocks out there. So what makes a value stock…valuable? Here are the main 3 things a stock needs to be considered a value stock:
- Low price-earnings-ratio
- Low price compared to cashflow
- Low price compared to “book value”
Basically, you’re going to be buying stocks that are worth more than they are currently selling for. It may seem obvious, but it can be scary.
“By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.”
Like Warren Buffett says: “Be fearful when others are greedy and greedy when others are fearful.”
Picking the actual value stocks can be difficult. Here’s a stock screener that makes it so much easier. You’ll notice a lot of companies that you haven’t heard of and that’s good, because it means you don’t have to deal with the inflation of the stocks, like you do with companies on the Dow and the top companies on the S&P 500.
The point of value investing is to lower your risk, while seeing a nice return over the long haul. Therefore, safety is key in making value investing decisions. In fact, if you don’t have a nice safety margin, you’re not investing in the value companies.
“Losing some money is an inevitable part of investing, and there’s nothing you can do to prevent it. But to be an intelligent investor, you must take responsibility for ensuring that you never lose most or all of your money.”
As I mentioned earlier, you’re analyzing the company, not the stock. You’re not looking for a hot stock price, but you do have to pay attention to the price of the stock to avoid overpaying for it. A great company may not be at the right stock price…yet. That just means you should hold off and invest in a different company right now. You can keep checking back in.
“By refusing to pay too much for an investment, you minimize the chances that your wealth will ever disappear or suddenly be destroyed.”
Safety means doing as much research as possible to assume as little risk as possible when you actually buy. Buying with a margin of safety means you’re buying the stock at a much lower price than the perceived intrinsic value. The important thing is to be able to accurately perceive the intrinsic value in the first place.
“Before you invest, you must ensure that you have realistically assessed your probability of being right and how you will react to the consequences of being wrong.”
But of course, you can’t completely minimize risk. You are investing after all, not putting money into your savings account or under your mattress…though, with the current inflation rate, that’s not much safer.
“Successful investing is about managing risk, not avoiding it.”
You go through all of the analysis and valuation to be a value investor to minimize risk as much as possible, but you’ll never eliminate it.
“Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.”
As mentioned above, the value investor needs to be aware of the current market and prices. This isn’t to buy and sell quickly, but it can occasionally mean buying or selling, because of a unusually low or high price.
“Always remember that market quotations are there for convenience, either to be taken advantage of or to be ignored…The best values today are often found in the stocks that were once hot and have since gone cold.”
Be aware, but don’t be emotional.
“The intelligent investor should recognize that market panics can create great prices for good companies and good prices for great companies.”
Awareness means knowing the difference between a good price and a great price. It also means waiting and watching for those prices. As a value investor, you’re not watching the market like a trader, you’re watching the market as a long term value investor who watches often and trades rarely.
“Even the intelligent investor is likely to need considerable will power to keep from following the crowd.”
Value investing isn’t the most difficult thing in practice. The idea of it is fairly straight forward, but it can be considerably difficult in discipline. Value investing requires you to hold stocks even when it seems like you should sell. It requires you to do the opposite of what most people are doing…but that’s a good thing, because most stock investors lose more than they earn.
Holding stocks when it seems like you should be trading them is quite possibly the most difficult part of value investing. That’s where the discipline comes in.
“Thousands of people have tried, and the evidence is clear: The more you trade, the less you keep.”
To be a value investor, you must be different. You don’t want to invest like everyone else.
“Mr. Market does not always price stocks the way an appraiser or a private buyer would value a business. Instead, when stocks are going up, he happily pays more than their objective value; and, when they are going down, he is desperate to dump them for less than their true worth…The intelligent investor shouldn’t ignore Mr. Market entirely. Instead, you should do business with him- but only to the extent that it serves your interests…Mr. Market’s job is to provide you with prices; your job is to decide whether it is to your advantage to act on them. You do not have to trade with him just because he constantly begs you to.”
“It should be remembered that a decline of 50% fully offsets a preceding advance of 100%.”
As Buffett says: “The first rule is not to lose and the second rule is not to forget the first rule.” It’s important to remember that, because it’s difficult to make up for large losses.
Return is highly important to the value investor. Who wants to devote all their time to the research without getting anything in return? A value investor is a defensive investor and a defensive investor wants to maximize returns, alongside of minimizing risk. You may be thinking: Isn’t that what every investor wants to do? Yes, but few have the ability and the discipline to do it. That’s what value investing can do for you.
“A defensive investor can always prosper by looking patiently and calmly through the wreckage of a bear market.”
The few months or years after a large correction (or even a crash) is the most profitable time for a value investor. As a value investor, you should always be watching for the times when everyone else is staying away from the market. That’s your time to buy.
Value investing is easier said than done, as are most things that actually work. It is possible though. Warren Buffett is living proof of that. But it takes dedication. Think of this as your introduction to value investing. Now you’ll want to read The Intelligent Investor and go look at my “top 75” list of finance books for other great titles.