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1-Page Summary of The Little Book of Value Investing
The Stock Sales
Many people buy stocks at the wrong time and pay too much for them. The stock market has a herd instinct, so investors let themselves get carried away by it. Value investors have a different approach and purchase shares when they’re cheap. Stocks don’t actually go on sale the way steak does, but prices fluctuate based on supply and demand. Buying low has been an effective strategy for many legendary value investors like Warren Buffett, Bill Ruane and Bill Miller because they all seek value in their investments.
Value investing is essentially buying stocks that are marked down. However, value investors don’t just look for cheap stocks; they pursue ones whose real worth is higher than their prices.
Value and Safety
Value investors are interested in the intrinsic value of a stock. They want to determine what it’s worth on its own, without reference to other stocks or the overall market. Benjamin Graham was one of the first people to write about this subject extensively and he came up with some formulas for determining intrinsic value. He also had some ideas about how you can tell if a stock is undervalued or overvalued by looking at the company as a whole instead of just focusing on its individual parts.
Value investing has been proven to protect investors and help them avoid market bubbles and panics. A study by Columbia University found that value-oriented mutual funds were able to register positive returns of 10.8% per annum during the difficult market period of 1999 through 2003, while avoiding popular stocks like those owned by other funds. The value fund managers also protected their shareholders from losses and even made respectable profits during a period when the overall market was tanking.
Value investors look for stocks that are undervalued by the market. They know that these stocks will eventually be more valuable, so they buy them when no one else wants them. This is a powerful lesson because it means value investors won’t purchase overvalued stocks because they’re always looking for good deals. Buying an overvalued stock is a surefire way to lose money, as the market will correct itself and bring down the price of those overpriced shares. When this happens, you’ll experience what Graham calls a “permanent capital loss.” Many people who bought into dot-com companies experienced this type of loss and never got their money back.
Safety Margin
Benjamin Graham was a very cautious man. He always sought companies he could buy for less than their intrinsic value, which is the true worth of that company. The margin between the purchase price and the intrinsic value gave him some protection against bad judgment or unpredictable events that might hurt the company. This principle has some accidental but important benefits.
If you invest in a stock that has intrinsic value, its price tends to increase over time. Moreover, if the market as a whole recognizes this intrinsic value, then your investment will be even more profitable because the price of the stock will rise to meet its intrinsic value.
Value investors are not swayed by the market’s ups and downs. They must be patient and wait for the right time to buy a stock, which is when it has fallen below its intrinsic value. Value investing is profitable in the long run, but timing the market is difficult because there’s no way of knowing what stocks will do next. There are many academic studies that show how hard it is to predict future returns on stocks, so you shouldn’t try to time them unless your goal is poverty.
Value investors tend to avoid companies that have high debt. This is because of the risk associated with debt. First, a company with a lot of debt may not be able to handle tough times well because it has to pay off its loans every month, and in bad economic times it might not have enough cash on hand. Second, heavily indebted companies may find themselves unable to make decisions without worrying about what their creditors want or allow them to do so they don’t lose money.
