\u201cThe Little Book of Value Investing\u201d by Christopher Browne is an amazingly simple and interesting book on Value Investing. Christopher was part of Tweedy, Browne company \u2013 one of the oldest value investing firms on Wall Street. This firm boasts of having served customers like Dean of Wall Street \u2013 Benjamin Graham and other legends on investing such as Walter Schloss, Warren Buffett etc. <\/p>\n\n\n\n
Some valuable insights from the book are captured here and can help you on your journey towards investing<\/a>.<\/p>\n\n\n\n Value investing is rooted in the differentiation between price and value. We pay a \u2018Price\u2019 to buy the business and receive the \u2018Value\u2019. This value from the business flows<\/a> to owners as claims on its Earnings\/Cash flows (as a going concern) and Assets (as a dead business). Roger Lowenstein in the foreword of this book states \u201cValue investing is buying securities for less than their intrinsic worth – of buying them on the basis of their underlying business value, as distinct from what is happening at the superficial level of the stock market.\u201d <\/p>\n\n\n\n As value investors are looking for great businesses at cheap prices, they are excited when markets are down. As Christopher states \u201cBuy stocks as you would buy groceries \u2013 when they are on sale, and not when they are high priced because everyone wants to own them. Just as it makes sense to buy groceries, cars and jeans on sale, it makes sense to buy stocks on sale, too. Stocks on sale will give you more value in return for your dollars invested. Bargains are found in the sales flyers and the new low lists, not in highfliers.\u201d <\/p>\n\n\n\n The author states, \u201cMost investors are driven by emotions that run the gamut from extreme pessimism to jubilant optimism. These emotions can drive valuations (read prices). The job of a smart investor is to recognize when this is happening and to take advantage of the emotional swings of the market. A rational investor sits back and waits for the market to offer stocks for less than they are worth and to buy the same stocks back for more than they are worth.\u201d He further states, \u201cCaution should not be seasonal. One should not rediscover caution when markets are falling and forget about it when they are rising. Maintaining a steady state of mind, whether we are in good times or bad, is the key to successful long-term investing.\u201d <\/p>\n\n\n\n Value Investing requires the ability to go against the herd \u2013 and risk of being called a dummy from time to time. It requires a mettle to buy those stocks<\/a> that the majority of investors don\u2019t want to own. Of course, why else would they be cheap? He further states \u2018Value investing does not always work\u2019. Indeed, it works in some years precisely because it does not work in some years. The mantra of success is doing the same thing religiously year after year without deviation. Liquidity, Sentiments and Fundamentals influence market prices in the same sequence. The First factor to contribute to price rise is always liquidity; with increasing prices, psychology comes into play – driving people to put more cash on the table to buy businesses. Both Liquidity and Sentiments create a positive feedback loop and the market keeps rising until it is taken away significantly from the Fundamentals. Then, some prudent investors start talking about markets being away from Fundamentals. All sorts of psychology \u2013 refusal, denial and then acceptance would come in to play off and on. On the downside, again, liquidity sucked from the system, along with psychology would create a negative feedback loop to restart the process of the market being quite away from fundamentals \u2013 this time on the downside. And, this is what moves the market up and down. <\/p>\n\n\n\n The stock market<\/a> always moves with expectations and unexpected results \u2013 called surprises in the market language. As surprises happen on both positive and negative sides, stocks keep reflecting them on prices continuously. <\/p>\n\n\n\n There are primarily two sources of value from a business<\/a> \u2013 Consistent Earnings (Cash Flows, to be precise) and then Assets as a dead business. Now, as a principle, investors need to pay as little as possible in comparison to these two sources of value. Therefore, it is critical to go beyond financials and understand where the business is headed. I believe – Quality results in quantity – Qualitative parameters would reflect in Annual Reports only over a period of time. <\/p>\n\n\n\n Christopher states, \u201cBook value, cheap earnings, balance sheet analysis and other metrics are key in identifying good prospects. But, if successful investing was a mathematical formula, everyone would have nothing but winners in their portfolios. There is some art to identifying the best prospects, and you should analyze your list of companies in greater detail.\u201d Analyzing qualitative dimensions of the company today would ensure you have great quantities tomorrow. <\/p>\n\n\n\n Value with growth is an amazing combination from an investors\u2019 perspective. It is important not to view \u2018value\u2019 and \u2018growth\u2019 as contradictory. Warren Buffett once said, \u201cGrowth and value are joined at the hip.\u201d Value buying may give upside on a standalone basis without any growth in the business. But, if layered with earning growth, would definitely be better – because, at the same P\/E, higher earnings will enhance the price of the stock and if the perception of investors towards growth opportunity shifts, it may result in complete rerating of stock and so expansion of P\/E. All put together, it could offer a significant opportunity for stock appreciation to the investors. <\/p>\n\n\n\n Value Trap is the term used when you catch a bad business<\/a> in the falling market thinking this is a great value buy. It is like when there\u2019s a sale in a retail store, one needs to be really careful on choosing merchandise. Buying things recklessly without quality consideration on sale may be a pain later. Christopher states \u201cDon\u2019t try to catch an overpriced, cheaply made falling knife.\u201d But, how do we know whether we are in a value trap? The answer lies in awareness about the features of the product one is buying and a reasonable sense of its valuation. In the context of investments, it means understanding the businesses you buy and their valuation. <\/p>\n\n\n\n Christopher captures this point interestingly, \u201cScreening for stocks that seem cheap on the surface is only a beginning. Blindly buying the new low list or the results of the screen could well end in investment disaster. These names are just a list of possible candidates for the shelves of our wealth-building store. We still need to examine the merchandise to make sure we are being offered quality goods at low prices and not shabby obsolete articles that are hopelessly overpriced even while appearing to be cheap.\u201d We have to remember that winning in an investment game begins with not losing. <\/p>\n\n\n\n How can you look at an insider\u2019s actions? Do these actions give us some clues? What if promoters, directors and top management are buying their own stock? Is it worth looking at the business at that point in time? Yes! <\/p>\n\n\n\n There could be several reasons for promoters to sell, but there is only one reason for them to buy \u2013 make money. In most cases, we have found that whenever management is buying, there are turning points in the business which is generally not seen to the public at large or are not there in the public domain. Obviously, insiders \u2013 promoters, directors and senior management have an intimate knowledge of the business<\/a> and would be the first ones to know. <\/p>\n\n\n\n Timing the market is virtually impossible. \u201cFooled by Randomness\u201d, a book written by Nassim Nicholas Taleb, is all about that \u2013 success generated in short term by random events may make us believe that we have learnt the art of being successful, but that is not true. <\/p>\n\n\n\n Christopher states, \u201cIn more than 35 years in the investment business, I have yet to find a short-term timing strategy that works. I simply do not believe that there is a way to accurately and consistently time short-term market movements, and again, the research of scholars seems to bear me out. Predicting short-term stock market direction, however, is a fool\u2019s game and a disservice to the investing public.\u201d Similarly, Warren Buffett stated quite rightfully, \u201cit is time in the market, not market timing, that counts.\u201d <\/p>\n\n\n\n Benjamin Graham always emphasized investment as an \u201coperation.\u201d<\/a> In other words, performance needs to be analyzed on a portfolio basis and not on an individual stock basis and that too over a period of time. Christopher states \u201cIn any given year, every stock portfolio will hold winners and losers, and it is virtually impossible to sidestep every loser. The point is to hold more winners than losers. By diversification, you provide yourself with insurance that if one of your stocks blows up, it will not severely impact your net-worth.\u201d <\/p>\n\n\n\n But, how many stocks would suffice from a diversification perspective \u2013 10, 20, 30, 50 or more. While there is no hard and fast rule on the subject, if we are holding so-called top tier companies in the portfolio, we may live with 10-15 stocks. But, if it is the small and mid-capitalized stocks, diversification needs to be wider to 25-30 stocks as chances of accident (stock selection risk) are higher here.<\/p>\n\n\n\nThe Concept of Value Investing<\/strong><\/h4>\n\n\n\n
The behavioural aspect of investing<\/strong><\/h4>\n\n\n\n
<\/s><\/p>\n\n\n\nMr Market\u2019s Behaviour<\/strong><\/h4>\n\n\n\n
Sources of Value in Business<\/strong><\/h4>\n\n\n\n
Buying Value with Growth<\/strong><\/h4>\n\n\n\n
The Value Trap<\/strong> <\/h4>\n\n\n\n
An Insider\u2019s actions<\/strong><\/h4>\n\n\n\n
Timing the market<\/strong><\/h4>\n\n\n\n
Diversifying your investments<\/strong><\/h4>\n\n\n\n
Money Managers <\/strong><\/h4>\n\n\n\n