What is Value Investing?

The raison d'etre of this blog is to explore Value Investing opportunities that are abound in Israel. Before I begin to discuss why Israel presents some great value investing opportunities, I think it might be worthwhile looking at what Value Investing is really all about. The next 20 or so posts will examine the different principles that make up Value Investing. After that – a bit about Israel – and then – hopefully dear reader, we will have the tools to begin analyzing some real deals.

So what is Value Investing?

Value Investing is an investment philosophy based on the framework developed and taught by the late Benjamin Graham and practiced by some of the world's most successful investors. The entire framework rests on the belief that the stock market will on occasion behave irrationally, and offer to willing buyers prices that are extremely attractive. In such instances, Value Investors, just like savvy shoppers, will swoop down and pick up 'bargains'.

Numerous research studies have demonstrated that Value Investing has shown superior returns over the long term when compared to other investment philosophies. One such recent study can be viewed here.

While Value Investing is easy to learn (there are no complex formulae), the discipline, focus, patience and extent of research that is required makes it difficult to implement.

Value Investors do not buy stocks; they invest in businesses. The difference between the two is like night and day and must be understood at the onset.

A typical Value Investment possesses all three of the following characteristics:

(1) A Great Business
(2) Run by Great Management
(3) Invested at a Great Price

Finding a business that meets all 3 criteria is not easy. This is why when such an opportunity is located Value Investors tend to invest a 'meaningful amount' of their funds – what Mohnish Pabrai refers to as 'backing up the truck'. This is also why Value Investors tend to be long-term oriented – once we've found 'value', we want to benefit as much as possible from the 'value' we discovered. Value Investors ignore the market and daily-fluctuations of stock price, and rather focus on business fundamentals such as sales, profit margins, cashflow, debt levels and inventory management.

Pretty simple huh? No fancy-shmancy PhD-level statistics and no Greek letters – just plain-old common sense.

You probably now have some / all of the following questions on your mind:

(1) What do Value Investors define as a great business?
(2) How do Value Investors locate great businesses?
(3) How do Value Investors recognize 'great' management?
(4) What do Value Investors consider a 'great' price

All these questions – and more - will be addressed in the coming posts.

I'll sign off with a relevant passage from Warren Buffett's 1992 Berkshire Hathaway Letter to Shareholders:

"We think the very term "value investing" is redundant. What is "investing" if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value - in the hope that it can soon be sold for a still-higher price - should be labeled speculation (which is neither illegal, immoral nor - in our view - financially fattening).

Whether appropriate or not, the term "value investing" is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics - a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield - are in no way inconsistent with a "value" purchase."