What started with the deceptively simple and entertaining The Little Book That Beats the Market has quickly grown into the "Little Book, Big Profit" series. The second installment comes from another renowned investor and is aptly titled The Little Book of Value Investing.
Author Christopher H. Browne is a managing director at Tweedy, Browne Company, a storied investment firm he joined in 1969. In 1920, Bill Tweedy founded Tweedy & Company in New York. In the 1930s, Tweedy developed a relationship with one Dr. Benjamin Graham, who had recently published a textbook titled Security Analysis. In 1945, the author's father, Howard S. Browne, and Joe Reilly joined the firm to create Tweedy, Browne and Reilly, which opened an office next to Graham on Wall Street. If that's not enough to get your value-investing juices flowing, Warren Buffett used Tweedy when he was first purchasing shares of Berkshire Hathaway
Tweedy, Browne is an esteemed member of the Superinvestors of Graham-and-Doddesville, a designation awarded to a select group of investors that first followed Graham's teachings. Buffett named seven successful investors in a talk given at Columbia University in 1984 to commemorate the 50th anniversary of Security Analysis. The transcript is available in the fourth edition of another Graham text, The Intelligent Investor, which we at The Motley Fool consider one of the top investing books of all time.
More history can be found at Tweedy's website, but for the inside scoop on the firm's investment philosophies, look no further than The Little Book of Value Investing.
Superinvestor lessons
This Little Book is full of references illustrating what it means to be a value investor and why investors should take notice. In Browne's words: "Why value investing? Because it has worked since anyone began tracking returns. A mountain of evidence confirms that the principles of value investing have provided market-beating returns over long periods. And it is easy to do. . Yet in the face of compelling evidence, few investors and few professional managers subscribe to the principles of value investing."
Browne estimates that perhaps only 5%-10% of the investment community embraces value investing. Later in the text, he takes a crack at explaining why those numbers remain so low. Temperament is an important consideration, according to Browne, as is investors' desire to follow the herd, because "the reputational and career risk of being a contrarian is far greater than the risk of going with the flow."
So what's at the core of value investing? Browne attempts to answer that with a colloquial tone reminiscent of Buffett, stating that it is advisable to "buy stocks like steaks . on sale." In other words, buy stocks when they are out of favor instead of when they are "high priced because everyone wants to own them."
Browne also highlights the importance of taking a long-term approach to investing, as opposed to Wall Street's obsession with quarterly earnings performance. "The most revealing aspect of the income statement is the trend over five or 10 years."
The second chapter quickly divulges two central tenets of value investing introduced by Graham in 1934: intrinsic value (determining what a company is worth) and "don't lose money." In other words, if an investor can appropriately value a company and buy it with an appropriate margin of safety, downside risk is minimized and there is greater likelihood that a profit will be made as the investment eventually trades up to its true worth. According to Browne: "When you pay full price for a stock -- a price equal to its intrinsic value -- your future gains may be limited to the company's internal rate of growth and any dividends." His recommendation is to buy stocks trading at low earnings multiples and look for investments that are trading for at least a third below their intrinsic value.
Other nuggets of wisdom
The Little Book is scattered with useful insight on what works for value investors. Brown recommends avoiding companies that have high levels of debt, as it gives lenders control over a company's fortunes when times are tough. His philosophy is that "a company should own twice as much as it owes." Liquidity and subsequent financial flexibility are mentioned numerous times throughout the book, emphasizing his aversion to debt.
Tweedy, Browne pursues a higher level of diversification than other superinvestors ("You should ask yourself: If one of my stocks went bankrupt could I slough it off?"). Browne also details how senior management, directors, and overall insider buying of a company's shares can lead to market outperformance to the tune of a two-to-one ratio. He also looks at return on invested capital, a favorite metric among Foolish investors.
As an investor interested in kicking the tires of my own investments, I found that Browne offers a very useful list for thoroughly examining a company. Instruction ranges from determining if a company has pricing power or can increase volumes, to whether it can drive profitability improvements through cost control, to whether it has unprofitable divisions, to what the outlook is for growth over the next five years. A comparison to other firms in the industry is also useful, as is management's share repurchasing strategy.
"Around the World With 80 Stocks"
Browne opens his sixth chapter by suggesting that going global can open the doorway to lucrative opportunities when searching for value, as more than half of the 20,000 publicly traded companies in the world can be found outside the U.S. Of the top 10 firms by global sales, BP
And while certain investors try their luck in developing countries such as Russia and China, Browne recommends staying with "stable economies with stable governments" -- Western Europe, Japan, and Australia, to name a few. This is likely due to the conservative bias among value investors and their need for long, stable track records. Chapters 15 and 16 are devoted to working through international accounting standards and what currency fluctuations can mean for an international investment.
A final word
I wouldn't characterize the material in this book as groundbreaking, but I found it beneficial to read the ideas of an individual whose lineage goes back to the days when value investing was creating the first vintage of superinvestors. I personally enjoy reading any book on the subject and believe that Fools would be well-served to place The Little Book of Value Investing on their holiday shopping lists.
For reviews of other great books, check out:
- Foolish Book Review: "Expectations Investing"
- Foolish Book Review: "The Intelligent Investor"
- Foolish Book Review: "Poor Charlie's Almanack"
For a resource closer to home, Philip Durell and his Motley Fool Inside Value newsletter actively embrace value investing, proving that the endeavor can lead to market-beating performance. Berkshire Hathaway is an Inside Value pick.
Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.
