Value is what you get. Price is what you pay.

Value Investing is an investment style that originates in the thirties with Benjamin Graham. Graham had been almost bankrupt by the 1929 crisis, and wanted to rethink the way he invested. Since then, many investors have followed the fundamental tenets of Graham and developed them in different directions : some people may say that the current investment styles of Warren Buffett or Seth Klarman have little to do with the original Graham “Net-Net” method.

However, all value investing methods, even if they differ largely, share three fundamental principles.

1. The investor thinks like a business owner.

This is the most important point. A Value Investor never sees a share as a paper whose price fluctuates, but as a fraction of a real business. As such, he always asks the following questions:

  • Is it a good business?
  • Would I be happy owning that business?
  • How much is this business worth? How much can it generate? What is its intrinsic value?
  • If this is a bad business, for how much could I liquidate it?
  • How is the management of the business?

And so on. The value investor never forgets that behind a share is a real underlying business.

Investing is most intelligent when it is businesslike. Graham, The Intelligent Investor


2. He asks for a big margin of safety

The investor may own the business, but he does not manage it nor operate it. Therefore, he acknowledge that a lot of things can go wrong :

  • He may have made a mistake in his valuation
  • The manager may be irresponsible
  • An unforeseen event can happen

To reduce the probability of losing money, the investor asks therefore a big margin of safety when buying a company. For instance,

  • Graham’s Net-Net stocks were only bought at 2/3 of liquidation value or below
  • Buffett insists on having a business that has an unattackable “moat”

And so on. The goal of the margin of safety is to mitigate the consequences of an investment mistake and reduce risk. The bigger the margin of safety, the lower the risk.

3. He behaves as a contrarian

Be greedy when others are fearful and fearful when others are greedy. Buffett

There is a reason the investor can buy stocks with a margin of safety related to their intrinsic value : People are selling them, and a lot. The business may have a temporary impairment, or may fall victim of a current lost of interest among other investors. Anyway, it happens often that the market overreact and does not price a company to its fair value. This is where the value investor jumps in and takes advantage of the market mistakes.

If you want above average results, you should not behave like everyone else.

You pay a high price for a cheery consensus. Buffett


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