Post of the Day
January 28, 2000
Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light.
What are these things called Value Investors?
Just what is a Fool? In the January 26, Fool on The Hill column, Bill Mann refers to a Fool who became disenchanted and therefor ditched his Oakmark Value Fund because the managers spent all of their time focusing on businesses that were "cheap." Meanwhile, their investors ended up holding a roster of crappy businesses that, in most cases, were depressed in price for good reason. Bill continues, This post, as beautiful as it was, brought about a litany of spleen venting about value investing in general, with one poster asking how to retrain value investors into Fools. Oops. I draw the line right there. There is no embargo against being a Foolish value investor. The two are not mutually exclusive.
But what are these things called value investors? Back to Bill: The best value investors, just like Fools, do not focus upon the little price movements of a stock. I hope that Bill is not saying that to be like a Fool you have to be one of the best of the value investors; that mediocre value investors need not even apply. Of course, this being a family site, his opinion of the really bad value investor is not permitted.
That didn't answer my question however. Again, what are these things called value investors? Bill? There is a grave difference between a value investor, one who looks for any company that has a price below intrinsic value, and what Ben Graham called a "cigar butt investor." He then goes on to explain the difference between a "cigar butt investor" and a value investor, but I can't get past the above sentence. What really is a value investor? What do Charlie Munger and Warren Buffet have to say about value investing?
Munger says, The whole concept of dividing it up into "value" and "growth" strikes me as twaddle. It's convenient for a bunch of pension fund consultants to get fees prattling about and a way for one advisor to distinguish himself from another. But, to me, all intelligent investing is value investing. That's a very simple concept. And I don't see how anybody could really argue with it. Buffett says, In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
In my opinion, Bill has the whole thing backwards. The question is not if value investors are worthy of being considered Fools, but are Fools value investors?
And thinking along these lines, the question that keeps screaming at me is "Why would anybody pay a price that is in excess of its intrinsic value?" If a value investor is a person who, as Bill says, looks for any company that has a price below intrinsic value, what does everyone that is not a value investor do? Do they look for stocks for which they can pay a price in excess of intrinsic value? And if so, why?
Bill continues, You see, what is true about value investors (as opposed to momentum investors) is that they elect to focus upon that long laugh they get at the end of the road for an awfully large number of laughs in between. I don't think so! What is true about value investors is that they understand two very elementary concepts, neither of which has anything to do with when and how often they laugh.
1) A value investor understands that the worth of a security is the present value of its future free cash flows. This is true whether it is a common stock, preferred stock, bond, warrant, or option.
2) A value investor then attempts to pay less than what he determined the security to be worth.
All of the other things like earnings, sales, equity, debt levels, the rate of growth in earnings, competition, labor relations, governmental regulations, capital spending, the sustainability of earnings, the predictability of earnings, etc. that concern value investors are just considerations for the intelligent determination of the amounts of future free cash flow. To make a value investor really happy there needs to be a margin of safety in the purchase price. Oh yes, they want to know the appropriate discount rate to use also. But that is about it.
Does Bill Mann find any value investors that he would be proud to consider a Fool? Well, there is at least one. He writes, One must only go back and look at the 30 year performance of Berkshire Hathaway to recognize the fact that value investing has retained relevance in a multitude of markets. Warren Buffett missed Cisco. But he also missed the Nifty Fifty, the advent of globalism, the first computer companies, telecommunications, and all of the other huge growth stories of the last 30 years. And yet there is no investor, growth, value, cigar butt, or momentum, who can touch his rate of annual return.
Is it a fault to miss the Nifty Fifty? I would consider it a virtue! Sure Buffett missed the Nifty Fifty. That is because when the Dow was making a 50% correction in 73-74, Buffett was spending all of his hoarded cash the purchase of stock in The Washington Post at give away prices! He is faulted for missing the early computer companies also. Another virtue. Name one besides IBM that still makes computers. Another fault: he missed "all of the other huge growth stories of the last 30 years." All? Bill, have you heard of a company in Atlanta that makes sugared water?
Bill summarizes, That is value investing. It is time tested. It is relevant. It emphasizes a lower risk profile than is currently being rewarded in the markets. And it is very Foolish. It seems like a very odd time to me when value investing ( and remember, Munger says that "all intelligent investing is value investing" ) is reduced to begging crumbs.
I believe that there are really only two approaches to investing. The value method, where an attempt is made to determine the worth of an asset and then to purchase that asset at an attractive price. And the other, for lack of a better word, is momentum investing. This second, nonvalue approach, is the purchase of a security based purely on the perception that the price will go up. It doesn't matter whether the perception is based on the price momentum of the stock, the concept or story behind the stock, the anticipation of a merger, or the recommendation of the neighbor's cat. The investor either has an idea of the worth of a security or he does not. If he makes and acts upon a determination that the security can be purchased for less than its worth, he is a value investor. If there is no consideration relating to the worth of the underlying business enterprises it is not a transaction based on value. It cannot be both, and it must be one of the two.
Again, let me quote Charlie Munger, "That's a very simple concept. And I don't see how anybody could really argue with it."
So what are these things called Fools? Are there really Fools who doubt the worth of the concept of value, that need to be reminded? If a Fool is someone who is uncertain of the virtues of the concepts of value investing, then he is a fool indeed. ( The small f is intentional. ) Bill did not make this claim, but is this the paradigm that has shifted: that value investing is no longer of any, well, value?
Instead, I insist that these principles are timeless. The idea that a security is worth the present value of its future free cash flows can never become obsolete, regardless of how many paradigms shift. I can't even begin to imagine what would begin to replace it. We may argue over the appropriate methods of determining value. My belief is that they are varied and vast. And we may squabble over all kinds of things. But the principles remain the same.
I always wonder at the attempts to disrespect value techniques. If, at threat of my life, I was forced to argue against the worth of value concepts I would not be able to begin. Again, Bill did not make these claims, but the only arguments I hear being used today to justify the abandonment of value concepts go something like: "this time it is different. We are in a new Era, or Economy, or Technological Revolution." The only thing these arguments do is highlight the role of change in society. But we always had change and we always will. And we all, value investors included, understand that change exists; that impermanence is. We know it every time we greet the morning sun, laugh in the falling snow, wonder at the newness of Spring, or smile with a new born child. Who are these people that think we can miss it?
Bill Mann insists, There is no embargo against being a Foolish value investor. The two are not mutually exclusive. I agree. But I would also like to lay claim to the following: There is no embargo against being a value investor that understands and considers the role and impact of change in our economy. Being a student of change and a value investor is not mutually exclusive. We value investors do not sanction to others a monopoly on the acknowledgment of impermanence. We know it too.
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