When it comes to books on investing, The Little Book of Value Investing is often cited as a great introductory book for someone who’s looking to learn more about the concept of fundamental analysis and value investing.
The author of the book, Christopher H. Browne, was a well-known value investor and partner of the investment firm Tweedy, Browne Company LLC – which counted legendary investors like Benjamin Graham, Walter Schloss, and Warren Buffett as clients when it was still operating as a brokerage firm before the 1950s.
The Little Book of Value Investing does an excellent job of encapsulating the key principles and framework of value investing. A list of 16 questions is provided to help readers select potential good investments, and a number of ratios and definitions are given to help readers understand more about balance sheets and income statements. I personally find the book a good, useful read — particularly for beginners.
Here are 10 key takeaways I gained from reading The Little Book of Value Investing:
1. ‘Buy stocks like you buy everything else, when they are on sale. Value investing forces investors to buy stocks that are cheap and to avoid pricey ones. It is based on two principles, namely intrinsic value and margin of safety. Relying on these two principles, investor focus on buying companies for significantly less than what they are worth (margin of safety), and then selling them when they approach their actual value (intrinsic value). However, the extent of the margin of safety that investors should apply is not shared in the book.
2. Browne uses a three-legged value stool that consists of the price-to-book (P/B) ratio, price-to-earnings (P/E) ratio, and the appraisal method to measure the intrinsic value of a stock. A stock is considered cheap when it has low P/B and P/E ratios. Under the appraisal method, stocks are also considered undervalued when they are selling at a significant discount to what a leveraged buyout (LBO) group might pay for an acquisition. The book also notes that investment methods and valuation criteria evolve with technology and business environments. Between the 1960s and 1980s, consumer product and service companies replaced manufacturing companies to dominate the U.S. economy. Net current assets thereby became a less meaningful measure of value as the former group of companies relied less on physical assets to produce earnings. Instead, earnings-based valuation models started gaining popularity among value investors. Growth is also an essential factor while choosing stocks.
3. ‘It’s a marathon, not a sprint.’ In our hyper-connected lives, patience is a rare virtue. We look for immediate results in almost everything we do including investments. However, stock investment is similar to property investment in that the intrinsic value of a stock, like property, is unlikely to skyrocket the day after you buy it. Instead, compounded returns are a powerful tool to substantially grow your investment portfolio in the long run. Browne also mentions in his book that if an investor cannot afford to invest for the long term, he should not invest in the first place.
4. ‘Like Graham, I have no faith in my ability, or in the ability of most others, to predict the direction of stock prices over the short term.’ If Benjamin Graham, the father of value investing, and Browne do not believe that anyone including themselves can forecast the movement of stock prices in the short term, then what about retail investors like you and me? No one could have accurately predicted subsequent economic impacts like the U.S. pulling out of the Trans-Pacific Partnership or the U.S.-China trade war following Donald Trump’s shock election in 2016. There are too many uncertainties in the stock market that are beyond our control. But what we can do is to invest in companies with good fundamentals over the long term.
5. ‘Buy when the insiders buy.’ Strong insider buying or company buybacks are usually a sign that insiders or the management think that business prospects are looking good and the company’s stock are undervalued at the moment. It is worth investigating companies that consistently execute share buybacks at low P/B or P/E ratios. The statement also reminds me of Peter Lynch’s well-known quote, ‘Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.’ As an investor, we can take advantage of such information when the opportunity arises.
6. When quarterly earnings of a stock fail to meet analyst expectations, investors sometimes panic and dump their shares. As a result, the stock may be temporarily mis-priced and, in certain occasions, drop below its intrinsic values. So here comes your opportunity. According to the author, when a good company is selling at a price below its intrinsic value, there is a good chance that its share price will recover and rise close to its actual worth if its fundamentals are still intact. However, it is not known how much time a stock will take to do so, which makes value investing rewarding for those who are patient.
7. ‘The investment world now equates activity with intelligence.’ In the book, Browne quoted scientist and philosopher Blaise Pascal: ‘All of humanity’s problems stem from man’s inability to sit quietly in a room alone.’ Comparing this to investors who trade in and out of stocks, Browne describes the phenomenon as drivers who keep switching lanes on the freeway amidst heavy traffic. It is not known if the drivers actually reach their destinations faster. Instead, we can be certain that ‘turnover is the enemy of compounding’ and it might be wiser to just hold onto a great company for the long term.
8. Apparently, FOMO is not just a thing in the social media, but also in the investment world. Value investing requires the ability to go against the herd and it can be difficult to buy out-of-favour stocks that the majority of investors refuse to own. At the same time, falling prices can be a double-edged sword. Value investors need to make sure they only pick fundamentally-sound companies with strong balance sheets and earnings. Increasing debt, decreasing earnings, excessive pension liabilities, technology disruption, and corporate/accounting fraud are red flags that should put companies on your no-thank-you list.
9. Look to invest globally, but in the developed markets. Browne advises investors to invest in developed markets rather than emerging ones. He wrote: ‘There seems to be a boom-bust cycle in all the less developed markets.’ While boom and bust cycles can also be found in the developed world, super-high growth rates in emerging markets can prove to be unsustainable in the long run and the market can come crashing down once the music stops playing. Investors have to be aware of situations where early investors and foreign investments inflate stock prices to unsustainable levels. Browne’s three-legged value stool will come in handy in such situations.
10. Browne likes simple businesses where there is ongoing demand for its products and services. Examples include banks, food and beverage, and consumer staples like detergents, toothpaste, and pens. Companies with ‘economic moats’ — as termed by Warren Buffett — including patent protection, brand names with broad consumer recognition, and size are even better candidates for investment. Nevertheless, no moat lasts forever. Businesses are increasingly disrupted by technology and even banking giants are challenged by digital banks nowadays such as Monzo in the United Kingdom and digibank by DBS in India and Indonesia.
The fifth perspective
To sum up, value investors look to buy stocks
below their intrinsic value with a margin of safety, but it is easier said than
done. Even when armed with our facts and research, we can still be swayed by
our emotions and the markets. So if you ever need some words of advice whenever
it feels like you’re going against the tide, Browne writes:
‘Value investors are more like farmers. They plant seeds and wait for the crops to grow. If the corn is a little late in starting because of cold weather, they don’t tear up the fields and plant something else. No, they just sit back and wait patiently for the corn to pop out of the ground, confident that it will eventually sprout.’
more: The top 5
must-read books on investing for beginners
The post 10 things I learned from The Little Book of Value Investing by Christopher H. Browne appeared first on The Top 6 forex cfd trading sins.