The Little Book of Value Investing

1. Buy Stocks Like Steaks: On Sale

Buy stocks like you buy everything else, when they are on sale.

Bargain Hunting Mentality. The core idea is to approach stock investing with the same mindset as shopping for everyday items. Just as you wouldn't buy a steak at its highest price, you shouldn't buy stocks when they are popular and expensive. Instead, seek out quality companies when their stock prices are temporarily depressed, offering a better value for your investment.

• This is a contrarian approach, going against the herd mentality that often drives up prices of popular stocks.
• It's about being patient and waiting for the right opportunities, rather than chasing the latest trends.
• The goal is to buy low and sell high, a fundamental principle of investing.

Value vs. Growth. The book contrasts value investing with growth investing, where investors chase hot stocks with high growth potential. While growth stocks can be exciting, they often come with inflated prices, making them riskier. Value investing, on the other hand, focuses on buying stocks that are undervalued relative to their intrinsic worth, providing a margin of safety.

• Value funds have historically outperformed growth funds over the long term.
• This is because value stocks are often overlooked and underappreciated by the market.
• The key is to buy good companies at bargain prices, not just any company that is cheap.

Emotional Discipline. The stock market is driven by emotions, and investors often get caught up in the hype and fear. Value investing requires emotional discipline, the ability to remain calm and rational when others are panicking or euphoric. It's about being a contrarian, buying when others are selling and selling when others are buying.

• This is not easy, as it goes against human nature.
• It requires patience, discipline, and a long-term perspective.
• The rewards, however, can be significant.

2. Intrinsic Value: Think Like a Banker

Think like a banker.

Determining Worth. Intrinsic value is the true worth of a company, what a knowledgeable buyer would pay for the entire business in a private transaction. It's not the same as the stock price, which can fluctuate wildly based on market sentiment. Value investors seek to estimate this intrinsic value to determine if a stock is undervalued or overvalued.

• This is similar to how a bank appraises a house before granting a mortgage.
• It involves analyzing the company's assets, earnings, and future prospects.
• The goal is to buy stocks that are selling for less than their intrinsic value.

Avoiding Overvaluation. Paying attention to intrinsic value helps investors avoid overpaying for stocks, which is a common mistake. Overvalued stocks are vulnerable to price crashes, leading to permanent capital loss. The book uses the example of Microsoft in 1999, which was trading at an unsustainable price-to-earnings ratio.

• The price of Microsoft stock declined significantly over the next few years, despite the company's continued growth.
• This highlights the importance of buying stocks based on value, not hype.
• It's about avoiding the "king is wearing no clothes" syndrome.

Two Approaches. There are two main approaches to determining intrinsic value: statistical and appraisal. The statistical approach uses financial ratios to identify undervalued stocks, while the appraisal method involves estimating what a company would be worth in a sale. Both methods aim to determine the true worth of a business, independent of its current stock price.

• The statistical approach is like GEICO screening for good drivers.
• The appraisal method is like a real estate broker valuing a house.
• Both methods are tools to help investors make informed decisions.

3. Margin of Safety: Belts and Suspenders

First rule of investing: Don’t lose money. Second rule of investing: Refer to rule number one.

Cushion Against Error. Margin of safety is the difference between a stock's intrinsic value and its purchase price. It's like a cushion that protects investors from losses if their estimate of intrinsic value is wrong or if unforeseen events occur. It's about buying stocks at a discount to their worth, providing a buffer against potential risks.

• This is a core principle of value investing, emphasized by Benjamin Graham.
• It's about being cautious and conservative, not reckless and speculative.
• The goal is to minimize the risk of permanent capital loss.

Avoiding Excessive Debt. A key aspect of margin of safety is avoiding companies with excessive debt. Companies with high debt levels are more vulnerable to economic downturns and may not survive difficult times. The book uses the analogy of a person with a rainy-day fund versus someone living paycheck to paycheck.

• Companies with low debt have more flexibility and control over their affairs.
• They are less likely to be forced into bankruptcy or liquidation.
• It's about choosing companies that are financially sound and resilient.

Diversification and Contrarianism. Margin of safety also includes diversification, spreading investments across different stocks and industries to reduce risk. It also involves being a contrarian, buying when others are selling and selling when others are buying. This is not easy, as it goes against the herd mentality.

• Diversification is like insurance, protecting against the risk of a single stock blowing up.
• Contrarianism is about taking advantage of market mispricings.
• It requires courage and conviction to go against the crowd.

4. Earnings on the Cheap: The Lower the Price, the Higher the Return

The lower the price, the higher the return.

Price-to-Earnings Ratio. The price-to-earnings (P/E) ratio is a key metric for value investors. It compares a company's stock price to its earnings per share. A low P/E ratio indicates that a stock is cheap relative to its earnings, suggesting a potentially higher return.

• The P/E ratio is calculated by dividing the stock price by the earnings per share.
• A low P/E ratio means you are paying less for each dollar of earnings.
• The inverse of the P/E ratio is the earnings yield, which reflects the return you would receive if all earnings were paid out as dividends.

Earnings Yield vs. Bonds. The book compares the earnings yield of stocks to the yield of bonds. A stock with a high earnings yield may be a better investment than a bond with a low yield, especially when considering inflation. Stocks can also grow their earnings over time, while bonds provide a fixed return.

• A stock with a P/E of 10 has an earnings yield of 10 percent.
• This is twice the return of a 5 percent Treasury note.
• Stocks can also pass the cost of inflation on to their customers.

Trailing vs. Forward P/E. The book discusses the difference between trailing and forward P/E ratios. Trailing P/E uses past earnings, while forward P/E uses analysts' estimates of future earnings. Value investors prefer to use trailing P/E, as it is based on actual results, not predictions.

• Wall Street analysts are notoriously inaccurate in their earnings estimates.
• It's better to buy stocks based on earnings that have already been tallied and reported.
• Low P/E stocks are usually low expectation companies, which can lead to positive surprises.

5. Buy a Buck for 66 Cents: Dial for Dollars at One-Third Off

Dial for dollars at one-third off.

Below Book Value. Some stocks sell below their net worth, or book value, which is the value of a company's assets minus its liabilities. This can be a sign of extreme undervaluation, offering a significant margin of safety. Buying stocks below book value was a favorite strategy of Benjamin Graham.

• Book value per share is calculated by dividing net worth by the number of shares outstanding.
• It's like buying a dollar for less than a dollar.
• This was the original specialty of Tweedy, Browne.

Historical Performance. The book cites research showing that stocks selling below book value have historically outperformed the market. This is true across different time periods and countries. It's a strategy that has consistently produced superior returns for value investors.

• The lowest grouping of stocks, selling for less than 30 percent of book value, has produced the highest returns.
• This is not just a theoretical concept, but a proven strategy.
• It's about buying assets at a deep discount.

Global Opportunities. The book emphasizes the importance of looking for stocks below book value globally. While U.S. stocks often sell at a premium to book value, there are many opportunities in other countries. This is especially true in developed countries with stable economies and governments.

• Examples include Dae Han Flour Mills in Korea and Conzetta Holding in Switzerland.
• It's about expanding your horizons and looking for bargains wherever they may be.
• It's about finding companies selling below their net cash balances.

6. Global Investing: There is a Global Search for Value

There is a global search for value.

Beyond Borders. The book argues that investors should not limit themselves to their home country. There are many great companies and investment opportunities around the world. By expanding your horizons, you can double the number of potential value opportunities.

• The United States only contains about half of the world's publicly traded companies.
• Many of the world's largest and finest corporations are located in Europe and Asia.
• It's about not limiting yourself to half the merchandise that exists in the world.

Not Just Diversification. While global diversification can be a benefit, the main reason to invest globally is to find more value opportunities. Foreign markets may not always move in the same direction as the U.S. market, but the real advantage is the increased pool of potential investments.

• The real reason to invest globally is to double the number of potential value opportunities.
• It's about finding stocks that are cheaper than their U.S. counterparts.
• It's about taking advantage of regional economic problems.

Developed Markets. The book recommends focusing on developed countries with stable economies and governments. Emerging markets can be risky and unstable, with a history of boom-and-bust cycles. It's better to stick to countries with a strong rule of law and transparent accounting standards.

• This includes Western Europe, Japan, Canada, New Zealand, and Australia.
• It's about avoiding countries with political and economic instability.
• It's about investing in places where your money is safe.

7. Stick to Your Guns: It's Time in the Market, Not Market Timing, That Counts

It’s time in the market, not market timing, that counts.

Long-Term Perspective. The book emphasizes the importance of a long-term perspective in investing. Trying to time the market is a fool's game, as it is nearly impossible to predict short-term market movements consistently. It's better to be fully invested in the market at all times to capture the periods when stocks rise the most.

• The biggest portions of investment returns come from short periods of time.
• It's about being in the game to win it.
• It's about accepting that you must endure some temporary market declines.

Avoid Market Timing. Market timing involves trying to buy low and sell high based on short-term market predictions. This is a difficult and often unsuccessful strategy. Studies have shown that market timers must be right a staggering 82 percent of the time to match a buy-and-hold return.

• Most investors buy high and sell low.
• The risks of market timing are nearly two times as great as the potential rewards.
• It's better to be a long-term investor than a short-term trader.

Stay the Course. The book uses the analogy of a plane flying from New York to Los Angeles. There may be some turbulence along the way, but if the plane is in good shape, there is no reason to bail out. The same is true for investing. If your portfolio is well-constructed, a bit of market turbulence is no reason to panic.

• It's about having the courage to stay the course.
• It's about focusing on the long-term goals, not short-term fluctuations.
• It's about being patient and disciplined.

8. Watch the Insiders: Buy When the Insiders Buy

Buy when the insiders buy.

Insider Buying. Corporate insiders, such as senior management and directors, often have the best information about a company's prospects. When they buy stock in the open market, it can be a strong signal that the company's fortunes are about to improve.

• Insiders are usually the first to know about positive developments.
• They are more likely to buy when they think the stock price is going higher.
• It's about following the smart money.

Share Buybacks. When a company buys back its own stock in the open market, it can also be a sign that management believes the shares are undervalued. This can increase the per-share value for other shareholders. It's a way for companies to return cash to shareholders.

• Share buybacks done below book value will increase the per-share book value of the remaining shares.
• It's about companies investing in themselves.
• It's about management putting their money where their mouth is.

Activist Investors. The book also mentions the importance of tracking activist investors, who accumulate large positions in companies and seek to influence management. Their presence can be a catalyst for change and can unlock hidden value.

• Activist investors are often successful in improving company performance.
• It's about finding companies that are ripe for change.
• It's about looking for catalysts that can make the market take notice.

9. The Physical Exam: A Thorough Checkup Will Help Avoid Mistakes

A thorough checkup will help avoid investing mistakes.

Balance Sheet Analysis. The balance sheet is a snapshot of a company's financial condition at a given point in time. It shows what a company owns (assets), what it owes (liabilities), and its net worth (equity). Analyzing the balance sheet is crucial for determining a company's solvency and ability to survive.

• It's like a doctor consulting a patient's chart.
• It's about understanding a company's financial health.
• It's about looking for red flags that may indicate problems.

Liquidity and Debt. The book emphasizes the importance of liquidity, the amount of cash a company can access in the short term. It also highlights the need to avoid companies with excessive debt. A strong balance sheet provides a margin of safety and ensures that a company can weather economic downturns.

• The current ratio is a key metric for assessing liquidity.
• The debt-to-equity ratio is a key metric for assessing leverage.
• It's about choosing companies that are financially sound and resilient.

Income Statement Analysis. The income statement shows a company's revenues, expenses, and profits over a period of time. Analyzing the income statement is crucial for understanding a company's earnings power and growth prospects. It's about looking at trends over time and identifying any red flags.

• It's about understanding how much money a company is making.
• It's about looking at the trends in revenues, expenses, and profits.
• It's about identifying companies that are growing their earnings consistently.

10. When Only a Specialist Will Do: How Do You Pick a Money Manager?

How do you pick a money manager?

Investment Approach. The book emphasizes the importance of choosing a money manager who has a clear and consistent investment approach. The manager should be able to explain their strategy in plain English and should have applied it consistently over time.

• It's about finding a manager who knows what they are doing.
• It's about finding a manager who sticks to their knitting.
• It's about finding a manager who is not a market timer.

Track Record and Consistency. The book recommends looking for a manager with a long-term track record of success. The manager should have a history of beating the market over several market cycles. It's also important to look at the volatility of the returns.

• It's about choosing a manager who has proven their ability to perform.
• It's about choosing a manager who is consistent in their approach.
• It's about choosing a manager who is not afraid to go against the herd.

Skin in the Game. The book suggests choosing a manager who has their own money invested in the fund. This ensures that the manager is aligned with the interests of their clients. It also suggests choosing a manager who is also an owner of the investment management firm.

• It's about choosing a manager who eats their own cooking.
• It's about choosing a manager who is not just a salesperson.
• It's about choosing a manager who is in it for the long haul.

Last updated: January 27, 2025