The Little Guide to Prudent Investing

Transcription

1 The Little Guide to Prudent Investing

2 What is Value Investing? Most analysts feel they must choose between two approaches customarily thought to be in opposition: value and growth. Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing. We view this as fuzzy thinking. 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 addition, we think that the very term value investing is redundant. What is investing if it is not the act of seeking value at least sufficient to justify the amount paid? Warren Buffet, 1992 Annual Letter to Shareholders

3 Core Tenets of Value Investing Invest with a Margin of Safety Capital Preservation Invest within Circle of Competence Capital Allocation Buy the Business, Not the Stock Capital Growth

4 Invest With a Margin Of Safety MOS: Central Thesis of Value Investing MOS= Intrinsic Value Price Emphasis is on Capital Preservation Protects the investor from both poor decisions and downturns in the market Because intrinsic value is difficult to accurately compute, the margin of safety gives the investor room for error "If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you'd need. If you're driving a truck across a bridge that says it holds 10,000 pounds and you've got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it's over the Grand Canyon, you may feel you want a little larger margin of safety..." Warren Buffett, 1997 Berkshire Hathaway Annual Meeting

5 Invest With a Margin Of Safety

6 Invest Within Circle of Competence Myfirstruleofhittingwastogetagoodballtohit.I learned down to percentage points where those good balls were. The box shows my particular preferences, from what I considered my happy zone - where I could hit.400 or better - to the low outside corner - where the most I could hope to bat was.230. Only when the situation demands it should a hitter go for the low-percentage pitch Ted Williams, The Science of Hitting (1986) The most important thing in terms of your circle of competence is not howlarge the area of it is, but how well you've defined the perimeter. If you know where the edges are, you're way better off than somebody that's got onethat's five times as large but they get very fuzzy about the edges. Ted Williams, the last major leaguer to hit.400 for an entire season (1941), is considered the greatest hitter of all times Warren Buffett (1995)

7 Invest in the Business, Not the Stock "In the short run, the market is a voting machine, but in the long run it is a weighing machine. Benjamin Graham, The Intelligent Investor It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price Warren Buffett

8 Defining Risk RISK = (AMOUNT OF LOSS) X (PROBABILITY OF LOSING) The greater the risk, does not necessarily mean the greater the return Risk erodes returns because of losses The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk. Rule No.1: Never lose money. Rule No.2: Never forget rule No.1 Warren Buffett Risk comes from not knowing what you're doing Warren Buffett

9 Volatility is Not Equal to Risk Madoff had no volatility Risk is not beta or standard deviation...it is how much you can lose on an investment and what the chance is that "loss" scenario is going to play out Seth Klarman

10 Keep It Simple The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective Warren Buffett I don't look to jump over 7-foot bars. I look around for 1-foot bars that I can step over There seems to be some perverse human characteristic that likes to make easy things difficult. Warren Buffett Warren Buffett

11 The Market Can Be Irrational Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed Ben Graham

12 Portfolio Diversification Wide diversification is only required when investors do not understand what they are doing Warren Buffett "We are able and willing to concentrate our capital into our best ideas. These days, other investors' idea of "risk control" is to own literally hundreds of small positions while making no size able bets, a strategy that might also be labeled "return control". It is clearly an advantage, but by no means without risk, to be able to concentrate our exposures. We work exceptionally hard to ensure that our largest positions are indeed our most worthwhile opportunities on a risk-adjusted basis." Seth Klarman

13 Investing the Graham Way Graham s stringent investment criteria maximized his Margin of Safety

14 Ignore Analyst Forecasts

15 Ignore Growth Forecasts "Even the intelligent investor is likely to need considerable willpower to keep from following the crowd." Benjamin Graham "It is absurd to think that the general public can ever make money out of market forecasts. Benjamin Graham

16 Go Deep to Hunt for Value U.S. Exchanges Large Caps 12 analysts per company 250 companies Mid Caps 7 analysts per company 1000 companies Small Caps 1 analyst per company 1,500 companies "Size is always a problem. With tiny sums to invest, it's extraordinary what you can find. Most of the time, big sums are one hell of an anchor Warren Buffett Micro Caps 0 analysts per company 3,000 companies

17 Buy and Hold Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell Warren Buffett We believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a 'romantic.' Warren Buffett We don't get paid for activity, just for being right. As to how long we'll wait, we'll wait indefinitely Warren Buffett

18 Investment Process

19 Process Source: Columbia Business School

20 Elements of Value Source: Columbia Business School

21 Asset Value Source: Columbia Business School

22 Earning Power Value Source: Columbia Business School

23 Earning Power Value Source: Columbia Business School

24 Value Creation Source: Columbia Business School

25 Evidence of Over-Performance

26 Investments in Companies with Low Price/Book Source: Tweedy, Browne & Co.

27 Investments in Companies with Low NCAV Source: Tweedy, Browne & Co.

28 Investments in Companies with Low P/E Source: Tweedy, Browne & Co.

29 Investments in Companies with Low P/E Source: Tweedy, Browne & Co.

30 Investments in Companies with Low P/E Source: Tweedy, Browne & Co.

31 International Markets: Value vs. Growth Source: Tweedy, Browne & Co.

32 Investment Returns Based on Market Capitalization Source: Tweedy, Browne & Co.

33 Investment Returns Based on Market Capitalization (US) Source: Tweedy, Browne & Co.

34 Investment Returns Based on Market Capitalization (US) Source: Tweedy, Browne & Co.

35 Investment Returns Based on Market Capitalization (Non-US) Source: Tweedy, Browne & Co.

36 Investment Returns Based on Market Capitalization (Non-US) Source: Tweedy, Browne & Co.

37 Results Based on Holding Period Source: Tweedy, Browne & Co.

38 Value vs. Growth Source: Tweedy, Browne & Co.

39 Investing in Companies with Low P/Cash Flow Source: Tweedy, Browne & Co.

40 Ben Graham s Performance Source: Kahn Brothers Group, Inc.

41 Walter Schloss Performance Source: Super Investors of Graham & Doddsville

42 Warren Buffett s Performance Source: Super Investors of Graham & Doddsville