Wednesday, November 08, 2006
Insights on value investing
This is a little reply I posted on the forum of Channelnewsasia to a guy who seems to practise value investment as well.
Yes, I agree with you that investors need only a few chances to make it successful in investing in the long run. The problem with most are firstly, the lack of patience, then, the inability to stay still and resist the temptation to keep on moving, then, patience and discipline. Like Charlie Munger once said: "It takes discipline and character to stay there doing nothing."
In life, you don't have to swing at everything -you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'"
Then it is important to understand some of the basic human characteristics. Some people they cannot stand others getting ahead of them even though they are making a profit themselves. These people they want to beat the market at all time at all cost. In life, you cannot outperform all the time at all the points between from now to then. In the short run, you may appears to lag the market, but if things are done in the right fashion, the long run will brings whatever that is out of line into line.
Though the value investing approach may appears to be boring or rather the lack of sex appeal, just like a married man yearning for a young and sexy lady, it keeps you out of trouble.
Then many investors do not recognize that they are being controlled by the market or rather by the price ticker that is shown day to day. The basic for every value investor is to recognize that the market is there to serve you, not to order you. Here is a big difference if you are really by nature a value investor. The best test is during a market downturn. In a market downturn, it shouldn't bother you. In fact, for any long term investor, it is an opportunity to increase your stake in a great business with a great management at a great valuation. Only to short term investors is a market downturn a threat or correction, not an opportunity.
Moreover, it takes a superb genius to figure out hundreds of smart decision during his investing lifetime. One may be able to make hundreds of "ok" decisions but not hundreds of superb decisions that can cause extraordinary returns. So to be extraordinary, making lots of decisions will not enhance your chance of doing good. Be discipline, keep searching and studying great businesses. At the time of studying the great business say for example, Coca Cola, the price may not be a good price to pay but if you study it constantly, and when the time comes where price is so undervalued, your study pays off and you whack as much as you have and sit back and wait for your payoff.
In value investing, we are like "FARMERS." which is coined by another legandary value investor, Christopher Browne (a student of Benjamin Graham and part of the inner circle friends of Warren). When the farmer plants his crops, at times, the crops may pop up of the ground late because of weather conditions. But he does not unearth the seeds that he planted and replant it like what many investors are doing. Many investors does not have the patience because "the crops does not pop up on schedule." They just sell out and jump on to the other lane which they think can bring them forward.
For me, value investing is a mindset. It does not really requires a whole lot of intelligence as long as you have a reasonable level of IQ. Like what Buffett said: "Success in investing doesn't correlate with I.Q. once you're above the reasonable level. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing." I think if you have say an IQ of 110, all the rest above it are wasted. Just like having lunch, you only need to eat so much, and if the table is filled with lots of food, all the rest are wasted. Same logic.
Then for those people who time the market. They really need a magic ball to tell them the future. In bull time, most value investor will not outperform the market and it is important to recognize this and why is it so? Because emotion have taken over logic. When you have emotions driving the price, you'll be amazed how high prices can deviate from what is the correct price. You can't calculate or value emotions but you know it will happen and what it will cause, it causes both the super bull market and the over pessimistic market. You may not know when the bubble will burst or how much it will bottom out. But you know in the future if prices are overdriven or underdriven, logic will prevail sometime in the future. Just like you throwing a bag of feathers, the feathers will float in the air for some time but you don't know when and where it will settle on the ground but it will.
The fact that humans are full of greed, folly and fear are legandary and predictable. The sequence of when each of this emotion will happens is not predictable.
It is only in times of pessimism that value investing returns the most. Pessimism is a huge reason why prices can be so undervalued to the point of being pervasive. Not that value investors like pessimism, but it is the price that it produces which is likeable. Here's something very contratrian, it's optismism that is the enemy of a value investor because it restrict firstly your chances of finding a real bargain and also, the limitation of the upside during a bull market where prices are almost at its roof.
Another thing to recognize is time is the friend of a great business and enemy of a bad business. This is also true towards value investing. It is able to stand the test of time.
I suggest for those who doubt the approach towards value investing to read the article "The superinvestors of Graham and Doddsville", it was printed in 1984 on a speech by Warren Buffett. It is not easy to find the article now but perhaps it could still be found online. Alternatively, I can email anyone of you if you are interested.