The Little Book of Value Investing

January 16th, 2015

The Little Book of Value Investing by Christopher H. Browne front cover

In 1969, Christopher H. Browne walked into the offices of Tweedy, Browne, and Knapp to ask his father for $5 for a train ticket home. The company brokered trades for one of the biggest names in value investing, Benjamin Graham, through whom the company was also introduced to his pupil, Warren Buffett. Browne had no clue that he would himself eventually be considered among the world's elite value investors, staying with the company until his death in 2009.

Value investing is a tough sell. It's easier for fund managers to sell investors on the bright future of the latest growth stock than to present last year's heavy-on-numbers, light-on-narrative balance sheet of an undervalued company. According to Browne, though, that lack of fireworks is part of what makes value investing so appealing, and he freely admits to value investing being an often boring endeavor. According to him,

Value investing requires the ability to go against the herd — and to risk being called a dummy from time to time.

Investors and even professional money managers are prone to herd mentality, panicking and selling their stocks when the market is low and buying when it's high, their returns limited through overconfidence in their own ability to time the market. One of the tenets of investing for the long run goes that time in the market is more important than timing the market. Referencing an American Century Investments study, Browne shares this thought-provoking tidbit:

If you had ridden out all the bumps and grinds of the market from 1990 to 2005 (through the go-go 1990s into the severe sell-off from 2000 to 2002), $10,000 invested would have grown to $51,354. If you had missed the 10 best days over that 15-year period, your return would have dropped to $31,994. If you had missed the 30 best days — one month out of 180 months — you would have made $15,730. Had you missed the 50 best days you would have come out a net loser, and your $10,000 would now be worth only $9,030.

Value investing involves buying stocks as if they were groceries: when they're on sale. The way Browne initially describes it, it seems uncomplicated:

The beauty of value investing is its logical simplicity. It is based on two principles: What it's worth (intrinsic value), and don't lose money (margin of safety).

Calculating price-to-earnings, price-to-book, earnings per share, net profit margin, and the multitude of other ratios to determine a company's intrinsic worth is relatively straightforward, but things get more complicated once you have to interpret those numbers. There are a number of plausible reasons for the ratios being what they are, and Browne does a bang-up job describing the different factors that may — or may not — influence the value of a company and the price of its stock.

The value investor must also deduce the significance of whatever news might be ticking in. For example, insiders buying stocks is almost always a good thing, but insiders selling stocks isn't necessarily a bad thing, and could just be a senior manager realizing gains to buy a house or fund a wedding. Don't panic, and don't get caught up in herd mentality. Well-run companies with their fundamentals in order will recover from market over-reactions, and incorporating a margin of safety means you have a safety net in case of declines in price. As Browne puts it:

Risk is more often in the price you pay than the stock itself.

I see how there might be some animosity from value investors and others utilizing fundamental analysis directed towards technical analysts, who buy stocks based purely on patterns in past price developments rather than on the fundamentals of the company itself. I came away thinking that a lot of work potentially goes into analyzing companies' fundamentals; Browne describes using literally months paging through foot-thick books filled with information about companies.

Of course, that was before the Internet, but then and now, especially when coupled with the tools available to us today, the value approach takes much of the emotion out of investing. Keeping in mind Warren Buffett's four E's — "The greatest Enemies of the Equity Investor are Expenses and Emotions" — this can't be a bad thing.

Very enlightening was the mini-class in accounting provided by the chapters on reading balance sheets and income statements, where Browne's line-by-line analysis tells you in plain English how the values reveal a company's health. Doing so is an integral part of value investing, but accounting is dry stuff, and I would have liked to see a financial report as the basis for these and a few other chapters. Many chapters each describe a single step in the process of valuation, and an example financial report — real or invented — would have provided some nice context. I highly recommend having a balance sheet and income statement of an actual publicly traded company sitting next to you as you read.

All in all, though, Browne expertly describes how to interpret the intentional and covert signals put out by companies, as well as the concrete critical question you need to ask when performing due diligence towards companies and your financial advisors. Apart from all the fundamental analysis, I came away with a lot of new knowledge about investor psychology, and there's a wealth of in-depth info crammed into the book's fewer than two hundred pages.