2004-09-03 / Business & Finance

What Is Value Investing

A few weeks ago I had the opportunity to spend a day in the offices of a large money manager. Brandes Partners, LLC has 500 employees and manages $45 billion. The firm adheres so strictly to “value” investing that one gets the feeling that each of the 500 em-ployees has a “V” tattooed on their arm. What is value investing? That’s what this column is about.

Many investors seek three primary benefits: capital appreciation, capital pre-servation in difficult markets, and superior long-term results. Value man-agers believe value investing philosophy is well suited to these aims.

The essentials of value investing are simple. Find a company that is financially strong - a company with measurable worth. When its stock is selling at a price below its estimated worth (what value managers refer to as its intrinsic value), they buy it. In time, they believe the market will recognize its value and the market price will rise. When this happens, they sell.

How is intrinsic value determined? The “bible,” according to value managers, is a book written in 1934 - Security Analysis by Benjamin Graham and David Dodd. In their book Gra-ham and Dodd presented the idea that stocks should be viewed as small parts of a business that are for sale. They also outlined a system for identifying the intrinsic value of a business based on extensive analysis of measurable, fundamental data. Brandes has adapted this system to today’s global marketplace, while remaining faithful to the original philosophy.

Why do stocks sell below their in-trinsic value? Markets are not always efficient or rational. In truth, they are often emotional. People (including pro-fessional investors) often buy on the basis of fad, hope, and fear. When companies lose emotional appeal, their market price falls, often to levels that are well below the companies intrinsic values.

Value mangers seek these undervalued stocks. In fact, the more undervalued the better - for two reasons. One, when market price is lower than value, profit potential is greater. Two, the gap between price and value also offers a margin of safety. A larger margin provides greater insulation for your investment in volatile markets.

Value mangers emphasize the im-portance of discipline and a long-term prespective. Value investors don’t follow the investment crowd. Instead, they search for overlooked opportunities that the crowd has passed up. Consis-tent application of this independent approach requires discipline and commitment. It’s not always easy, but confidence in research and courage in their convictions often enables value managers to profit from their against the grain style.

Company founder, Charles Brandes, told a story of making money in a company that was quite “beaten up” by the press. Do you remember the Union Carbide factory in Bhopal, India that killed almost 2,000 people? Brandes said that after the tragedy he rechecked his numbers and found Union Carbide to be a sound company so he bought additional shares, held them to his sell point, and made a tidy profit.

When it comes to results, value investing emphasizes the accumulation of lasting wealth over the pursuit of potentially fleeting short-term gains. Accordingly, value managers expect to realize significant profit as the market recognizes the true worth of their purchases. They understand that this might not occur quickly. Typically, value managers often will hold a stock for 3 to 5 years, or until the stock price climbs to their sell target.

Warren Buffett is also a value manager and a disciple of Graham and Dodd. He runs Berkshire Hathaway and is generally considered to be the shrewdest investor in the world.

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