The Art of Value Investing is a collection of wisdom from professional value investors.
My impression of this book is mixed. While it provides a good overview of different styles of value investing, it lacks depth. It jumps from a few paragraphs from investor A to a few paragraphs from investor B, and so on, grouped by topic. Because of that I often found myself thinking: "No, please, don't switch to someone else again, let the current person talk more about the respective topic." Hence I wish the authors limited the number of investors mentioned to just a handful, but giving them more room for their insights and thoughts.
Value investing means different things to different people, but value investors' core belief is that equity markets regularly offer – for a variety of different but predictable reasons – opportunities to buy stakes in companies at significant discounts to conservative estimates of what those businesses are actually worth. If you can consistently get the value of the underlying businesses right, pay deep discounts to those values in buying the companies' stocks, and maintain your conviction and discipline while conventional wisdom regularly goes against you, you can beat the market.
"All Sensible Investing Is Value Investing"
Value investors typically:
Focus on intrinsic value – what a company is really worth – buying when convinced there is a substantial margin of safety between the company's share price and its intrinsic value and selling when the margin of safety is gone. This means not trying to guess where the herd will send the stock price next.
Have a clearly defined sense of where they'll prospect for ideas, based on their competence and the perceived opportunity set rather than artificial style-box limitations.
Pride themselves on conducting in-depth, proprietary, and fundamental research and analysis rather than relying on tips or paying attention to vacuous, minute-to-minute, cable-news-style analysis.
Spend far more time analyzing and understanding micro factors, such as a company's competitive advantages and its growth prospects, instead of trying to make macro calls on things like interest rates, oil prices, and the economy.
Understand and profit from the concept that business cycles and company performance often revert to the mean, rather than assuming that the immediate past best informs the indefinite future.
Act only when able to draw conclusions at variance to conventional wisdom, resulting in buying stocks that are out-of-favour rather than popular.
Conduct their analysis and invest with a multiyear time horizon rather than focusing on the month or quarter ahead.
Consider truly great investment ideas to be rare, often resulting in portfolios with fewer, but larger, positions than is the norm.
Understand that beating the market requires assembling a portfolio that looks quite different from the market, not one that hides behind the safety of closet indexing.
Focus on avoiding permanent losses rather than minimizing the risk of stock-price volatility.
Focus on absolute returns, not on relative performance versus a benchmark.
Consider stock investing to be a marathon, with winners and losers among its practitioners best identified over periods of several years, not months.
Admit their mistakes and actively seek to learn from them, rather than taking credit only for successes and attributing failures to bad luck.
Field of Play
Circle of Competence
When successful investors talk about ideas that have gone awry, one key reason often cited has been venturing into an industry, company, or market situation with which they don't have experience or don't yet have a full command. Enough can go wrong even when you're in the center of your circle of competence, why increase the chance of mishap by operating outside of it?
Regardless of how broad or narrow their field of play, the best equity investors are able to articulate clearly where they expect to find investing opportunity and why. This circle-of-competence definition includes the characteristics of companies of interest, with respect to such things as their size, where they operate geographically, their business models, and the industry or industries in which they compete. It also includes the situations that the investor has found can lead to potential share mispricing, such as where a company is in its evolution, where an industry is in its cycle, and when a company or industry is likely to be neglected or misunderstood. All of this informs where the investor will – and won't – look for ideas, and the tactics he uses to generate them.
One of the most basic distinctions investors make in defining their field of play concerns company size. How big a company is can say a lot about its complexity, the sustainability of its business model, how actively followed it is, the volatility of its stock price, and why it might be mispriced.
Central to any accomplished investor's definition of his circle of competence is a description of the industries – or more generally, the types of businesses – on which he focuses. Hard-earned experience would appear to be the most impactful teacher here – the emphasis is usually more on where they will not invest, rather than on where they will.
Deficient Market Hypothesis
An all-too-common error that novice investors make is to assume a consistent connection between the success of a business and the success of an investment in that business. There's no question that successful companies can also be outstanding investments, but that's not necessarily the case. Winning investments arise when the current market price of a company's stock underestimates what you believe its current value is – and you turn out to be right.
Look at almost any company's market value over a multiyear period if you want assess the efficiency of the market. Even the largest, most stable and most liquid company will often exhibit a surprising variability in market price from high to low – a variability that almost certainly goes beyond the underlying change in the company's actual value. This spells opportunity for astute investors.
[...] if an investor doesn't know why something might be mispriced, the chance of it actually being mispriced significantly decreases.
While value investors are typically considered a risk-averse lot, that's more a reflection of the price they're willing to pay for any given investment than the types of situations they most often pursue, which are often fraught with uncertainty. As companies constantly evolve and change in response to industry or company-specific challenges and opportunities, the lack of clarity around those changes – and the risks inherent in the potential outcomes – can cause share prices to diverge widely from underlying business value. The ability to recognize and capitalize upon that dynamic is a key element of what sets top investors apart.
Building the Case
Cutting Through the Noise
Almost as important as identifying the extent to which a stock is undervalued is assessing what can make that misjudgment by the market go away. After all, the proverbial "50-cent-dollar" that value investors seek will produce a very different investment result if the gap between price and value closes within one year, or if it takes 10 years, For that reason, most – but not all – successful investors put emphasis in their analysis on the potential catalysts that can trigger an enhanced market appreciation for a company's business and its shares.
Getting to Yes
Through creative and diligent research you may uncover fascinating companies in wonderful industries. Through brilliant and incisive analysis you may see unfolding for a company positive events that mere mortals would miss. But all of that is for naught if you pay too much for a stock relative to what you get. Price obviously matters – the cheaper it is relative to what you believe a company is worth, the better.
Consistent with value investors' emphasis on what can go wrong with any given investment, they typically in their valuation work assess a variety of possible upside and downside value scenarios and, implicitly or explicitly, assign probabilities to each before making any final judgments.
There's no question, of course, that intelligent buying decisions are a prerequisite to successful investing. But there's also no question that smart buying isn't at all sufficient to insure success. Equally important are the less-sexy aspects of equity investing involved in portfolio construction and management. How are positions sized? How many positions are held? How actively are holdings traded? How are portfolio risks assessed and what efforts are made to mitigate them? Is hedging a part of the strategy? Is shareholder activism? Finally, among the most vexing topics an investor must address: How do I decide when to sell?