“Once you adopt a value-investment strategy, any other investment behaviour starts to seem like gambling.”  Seth Klarman

Recently I have started a series of article on value investing. The first article, “What is Value Investing” in the link below explains what value investing is. It attempts to dismiss the myth that most people have, the misconception that value investing is about buying stock with low price-to-earnings, or price-to-book value, etc.

https://klse.i3investor.com/blogs/kcchongnz/173926.jsp

Value investing is intelligent investing. Value investing is about looking for a mispriced gamble, getting more than you are paying for. You must know about the business and hence the value the business. It’s the ‘processes of picking up bargain stocks that value investing is all about. You must know what you are getting into.

Following that, I wrote another article to explain some “Key principles of Value Investing”, in the link below,

https://klse.i3investor.com/blogs/kcchongnz/174104.jsp

Share prices don't exist in a vacuum. Instead, they represent what it costs, at one point in time, to buy a tiny proportion of a company listed on the share exchange - a company that employs people, produces goods or services and, hopefully, generates revenue, profit and cash flow. Alongside this quoted share price, value investors also take account of a company's underlying, or "intrinsic" value (IV), or an estimate of the true value of the company.

Share prices, you may have noticed in the above figure, vary enormously over the course of a year, sometimes even over a week. But a business's revenue, profit and cash flow rarely change anything like as much as that. Hence the price of a share does not necessary represent the value of a company. The price of a company's shares is only a reflection of what people are willing to pay for them at any given time. Sometimes, usually when prices are rising, they're greedy. When prices fall, they become fearful and rush for the exits. All this emotion can push the share price a long way from the intrinsic value of the underlying business. That is why Benjamin Graham said Mr Market is a crazy guy.

Value investors aim to benefit from this by buying shares when they're trading at significantly less than their intrinsic value, or at a margin of safety (MOS). Or, to put it another way, buying a dollar's worth of value for 50 cents. Unlike the share price, you can never get the exact figure for the intrinsic value but you can sometimes make a reasonable estimate by undertaking "fundamental analysis", which involves looking at a company's financial statements over time and assessing its management, markets and growth potential.

Hence the utilization of the principles of value investing to obtain extra-ordinary return from the share market is plausible; buy shares when Mr. Market gets moody and offer you a discount when the share is sold at a price way below its IV, or a good MOS, and sell when Mr. Market gets euphoria and offers a good price close to the IV of the share.

In life, rarely things work all the time, especially when you talk about the share market when human emotion and various economic and industrial variables. But it works better than all the alternatives I can think of, especially over a longer period of time. This has been shown in various research.

How Profitable is Value Investing?

Benjamin Graham is widely regarded as the dean of value investing as well as the whole industry of Security Analysis.  This influence stems not only from his published works but also from the eventual fame and fortune of the pupils that he taught at Columbia University who included Warren Buffett. It is thanks to Graham that we have a whole catalogue of quantitative bargain share strategies at our disposal with such obscure titles as ‘Net Net Bargains’ and ‘Net Current Asset Value Bargains’ as well as a whole ream of other concepts that we’ll explore including Margin of Safety.

In a paper titled “The Super Investors of Graham and Doddsville”, Warren Buffet showed the track records of each of nine disciples of Benjamin Graham showing that they all generated annual compounded returns of between 18% and 29% over track records lasting between 14 to 30 years. Is it likely that these individuals from the same school of thought could all beat the market over a generation if the share market was a place of luck? Warren Buffett doubted it most eloquently when he said “I'd be a bum on the street with a tin cup if the market was always efficient”.  Let’s have a look at their profit history...

In his latest book, “The value Investors, Lessons from the World’s Top Fund Managers” published in 2012, Ronald W. Chan interviewed twelve top fund managers from US, Europe, and Asia using various forms of value investing expounded by the Super Investors of Graham and Doddsville. The evidences showed it has worked all over the world.

In Malaysia, most of us know Mr. Fong Si Ling, popularly known as Coldeye, is a successful value investor. He has written at least three books in Mandarin on value investing.

The value investing camp splits into two on this topic. Fundamental value hunters who follow Warren Buffett tend to fall into the ‘focus portfolio’ camp believing that you should put all your eggs in just a few baskets and watch them like a hawk.  An alternative approach is that espoused by the more ‘quantitative’ value farmers who seek to ‘harvest’ the value premium from the market, such as that of Joel Greenblatt of the Magic Formula Investing fame. Graham recommended owning a portfolio of 30 bargain shares to minimise the impact of single shares falling into bankruptcy or distress, while Joel Greenblatt recommends a similar level of diversification in his Magic Formula strategy. 

Conclusions

Value investing has been shown to work in almost all markets in the past. The reasons given why it worked and will continue to work are plausible. However, embarking in value investing, and staying on course, is not easy. Most new “value investors” are upset after one week, mad after one month, and gone after one year. They want their share price to go up instantly after purchasing, and continues to go up forever.  In fact, most investors aren’t cut out for value investing. This is simply because value investing can get really painful, and human nature shrinks from pain. Making money on value shares – which is the goal of every value investor – is harder than it sounds and can take years to play out.

In fact, identifying a value share and buying it is a relatively easier proposition. But value investing is difficult, and because…

• You need to have patience, and a lot of it
• You must be disciplined
• You must mind your behaviour
• You must know when to go against the crowd
• You must read a lot (annual reports, investing books etc.)

In all, value investing requires hard work. This is probably the reason you won’t find many value investors out there. But whoever has had the patience to practice value investing in its real form, has done wonders for his share portfolio.

My personal experience in value investing shows that it works very well in Bursa. This I will deliberate in the next article.

For those who wish to know more about value investing, or wish to follow some stock picks I Bursa following the principle of value investing may contact me at,

ckc14invest@gmail.com

Yes, it is increasingly harder to find participants interested in value investing nowadays. That may also be a good opportunity to embark in this proven successful investment strategy to build long-term wealth as there is less competition.

KC Chong