Should a value investor imitate Ben Graham?
Whilst many use Ben Graham’s models for intrinsic value to evaluate the attractiveness of companies, I don’t. Let me explain why.
Just before I begin though, I want you to know that I am a little nervous about publishing a post advocating against a strict Graham-approach, as it may put a few noses out of joint. So, unlike many of my other posts, I have referenced what I believe to be the pertinent quotes that I have read and that brought me to or reinforced my conclusion that value investors should move on from many parts of Graham’s framework.
In the 1940’s Benjamin Graham (who passed away in 1976) was regarded “as a sort of intellectual dean of Wall Street, [and] was one of the most successful and best known money managers in the country.”[1] In 1949, an eager Warren Buffett read Graham’s book The Intelligent Investor and the rest, as they say, is history.
Warren Buffett regards Graham’s book Security Analysis as the best text on investing, regularly referring investors to that piece and his other seminal The Intelligent Investor. Many of you will also know one of my favourite Graham publications, The Interpretation of Financial Statements.
Yet whilst Buffett remains an adherent and advocate of Graham’s Mr. Market allegory and the Margin of Safety, thanks to his long time partner at Berkshire Hathaway, Charlie Munger, he has moved far from the original techniques taught and applied by the man described as the ‘father of value investing’.
Ben Graham advocated a mostly, if not purely, quantitative approach to finding bargains. He sought to buy businesses trading at a discount to net current asset values – what has been subsequently referred to as ‘net-nets’. That is, he sought companies whose shares could be purchased for less than the current assets – the cash, inventory and receivables – of the company, minus all the liabilities. Graham felt that talking to management was sort of cheating because smaller investors didn’t have the same opportunity.
Whilst the method had been very successful for Graham and the students who continued in his tradition, people like Warren Buffet, Walter Schloss, and Tom Knapp, Graham’s ignorance of the quality of the business and its future prospects did not impress Charlie Munger. Munger thought a lot of Graham’s precepts “where just madness”, as “they ignored relevant facts”.[2]
So while Munger agreed with Graham’s basic premise – that when buying and selling one should be motivated by reference to intrinsic value rather than price momentum, he also noted “Ben Graham had blind spots; he had too low of an appreciation of the fact that some businesses were worth paying big premiums for” and “the trick is to get more quality than you pay for in price.”[3] When Munger referred to quality, he was likely referring to the now common belief held by many sophisticated investors that an assessment of the strategic position of a company is essential to a proper estimation of its value.
In 1972, with Munger’s help, Buffett left behind the strict adherence to buying businesses at prices below net current assets, when, through a company called Blue Chip Stamps, they paid three times book value for See’s Candies.
See’s is a US chocolate manufacturer and retailer – whose product I have purchased and eaten more than my fair share of, whose factory I have toured and whose peanut brittle ranks with the best I have ever tasted.
Buffett noted; “Charlie shoved me in the direction of not just buying bargains, as Ben Graham had taught me. This was the real impact he had on me. It took a powerful force to move me on from Graham’s limiting view. It was the power of Charlie’s mind. He expanded my horizons”[4] and, “… My guess is the last big time to do it Ben’s way was in ’73 or ’74, when you could have done it quite easily.”[5]
So Buffett eventually came around, and the final confirmation, for those still advocating the Graham approach to investing, that a superior method of value investing exists was this from Buffett; “boy, if I had listened only to Ben, would I ever be a lot poorer.”[6]
Times in the US were of course changing as well, and it is vital for investors to realise that the world’s best, those who have been in the business of investing for many decades, do indeed need to evolve. In the first part of the twentieth century industrial manufacturing companies, for example, in steel and textiles, dominated the United States. These businesses were loaded with property, plant and equipment – hard assets. An investor could value these businesses based on what a trade buyer might pay for the entire business or just the assets, and from there, determine if the stock market was doing anything foolish.
But somewhere between the 1960’s and the 1980’s many retail and service businesses emerged that had fewer hard or tangible assets. Their value was in their brands and mastheads, their reach, distribution networks or systems. They leased property rather than bought it. And so it became much more difficult to find businesses whose market capitalisation was lower than the book value of the business, let alone the liquidating value or net current assets. The profits of these companies were being generated by intangible assets and the hard assets were less relevant.
To stay world-beating, the investor had to evolve. Buffet again: “I evolved…I didn’t go from ape to human or human to ape in a nice, even manner.”[7]
Many investors cling to the Graham approach to investing even though some, if not many of his brightest and most successful students, moved on decades ago.
If you are reading this and want to adopt a value investing approach, there is no doubt in my mind that your search for solutions will take you into an examination of the traditional Graham application of value investing. It is my hope, however, that these words will serve as a guide towards something more modern, more relevant and, whilst can’t be guaranteed, more profitable.
If you have tried to adopt the Graham approach and had some successes (or failures) and are keen to share, I would be delighted if you post your own experiences here at my blog. Alternatively, if you have reached your own conclusions about the best approach to value investing, feel free to post a comment by clicking the Leave a Comment link just below and to the right.
Posted by Roger Montgomery, 30 April 2010.
[1] Damn Right. Janet Low. John Wiley & Sons 2000. Pg 75
[2] Damn Right. Janet Low. John Wiley & Sons 2000. Pg 77
[3] Damn Right. Janet Low. John Wiley & Sons 2000. Pg 78
[4] Ibid
[5] Robert Lezner, “Warren Buffett’s Idea of Heaven” Forbes 400, October 18, 1993 p.40
[6] Carol J. Loomis, “The Inside Story of Warren Buffett,” Fortune, April 11, 1988 p.26
[7] L.J.Davis, Buffett Takes Stock,” New York Times Magazine, April 1, 1990, pg.61.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Richard Stooker
:
Hi, Roger,
I think a lot depends on the meaning of “value” investor.
The problem is, stock valuation is more of an art than a science, no matter what anybody claims or how many ratios and numbers get thrown around.
Graham’s heydey was in the 1930s, when the stock market was so low because of the Depression that he could find companies with physical asset valuations above their market caps. Today, if you could find such a stock you’d have to get in line behind the corporate raiders.
In one book about Buffett I recall reading where early in his career he did manage to find a company with more cash in the bank than the market valued their stock for, so he bought a bunch of shares, enough to become a director.
Trouble was, the rest of the directors regarded him as an outsider trying to butt in on their business. They voted down all his suggestions for putting the cash to use.
Paying $1 for $2 isn’t so fun when you can’t spend any of it!
I believe Buffett now pays great attention to the company’s future cash flow prospects. This must include looking at their ROI, brand name value, cash flow and so on.
Those of us who can’t either buy the company outright or call up the CEO to give them business advice, are, in my opinion, best advised to imitate Buffett by buying stocks with a strong history of paying dividends.
Liz
:
It is more than six months since this article inspired me to test the “net-net” theory… it took me a bit of time to find the initial shares and I started a paper portfolio of 11 Australian shares on 21 June 2010. Many of these shares I also subsequently purchased in small quantities. I have since replaced 3 of the shares as they have left the portfolio for various reasons (i.e. no longer qualified/takeover/radical price move). By my calculations, in the period since (6.5 months), the net-net portfolio has gained 114%.
It is also worth noting that only 2 shares out of 14 have so far produced a negative return – including one that was removed from the portfolio after it was determined that quasi-equity should not have allowed it to be included.
On the downside, given the rarity of these types of shares and the fact they usually only occur in extremely neglected situations, most were not very liquid and proved difficult to purchase/sell in any quantity.
As far as a simple “invest by formula” strategy goes, the results suggest to me that it is probably one of the safer ones – at least when they are actually possible to find and buy.
Michael
:
What industry do you work in? Salmat
Who do you regard as the best company in that industry? Salmat
What do you think makes them the best? Market share, IT innovation, historically low debt except for one recent purchase of HPA.
Could anyone eventually knock them off the perch? Who do you think is the most likely to? It would have to be an over seas company moving in, but I think they would buy Salmat.
Roger, I’d love to see your valuatioin of this company especially as there is a staff share offering on.
admin
:
Hi Michael,
Thanks for that insight not only into the company but also into your enthusiasm for them. It says a great deal when an employee is so positive about their place of work. I haven’t looked at Salmat recently so I will put it on the list.
Hernan
:
Hi Roger,
I think one stock that would come close to qualifying under Ben Graham’s criterion is Lemarne Corporation (LMC). It has significant net working capital, though its NWC per share is less than its current share price. Trouble is of course that it is a small, tightly held and illiquid stock and the reason it has so much cash is that it sold one of its businesses last year. It has however been returning cash to its shareholders via special (unfranked) dividends.
Cheers,
Hernan
admin
:
Hi Hernan,
Thanks for the suggestion. Will go and have a look.
Tony
:
Hi Roger,
Coincidentally I finished reading Securities Analysis recently. The one thing that I took away from the book was Ben Graham’s impressive development of the philosophy for investing in shares – First and foremost you have a principal sum that must be protected. Graham’s evolution of the principles of investing always rooted themselves solidly in protecting the principal. He starts as we all must at the risk free invesement: US government bonds. He then investigates which bonds, and under what circumstances, may be considered to return better than t-bonds WITHOUT GIVING UP ANY OF THE SECURITY. He then develops the analysis to include shares, but uses the same principle – are there security investments that provide a better return than corporate bonds (which themselves ave been selected to provide a better return than government issued bonds)? Under no circumstances does he trade risk off for reward. THIS IS THE KEY FACT. If the share or bond has any element of risk in it, then it is not safe as a harbour for capital at any rate of return. In this way, he forshadowed The Black Swan more than 50 years before Taleb. And perhaps even paraphrased Ralph Nader, as any share that contained risk was UNSAFE AT ANY SPEED (ie return).
The philosophy developed in Securities Analysis goes onto examine the risks inherant in investing and concluded that most investing was speculation. That is, any business case which requires a forecast was speculation. So throw away the DCF models people (unless they simply plugged the past 10 years average returns into the future projections).
So what is left? The net nets.
I accept that the net nets were a process essentially derived by regression analysis. IE Graham, posed the question what range of ratios represented safe investments? And then reviewed years of secutiry analysis to come up with the metrics to guide investment ( rather than speculation).
I think the process remains in tact as a discipline derived from the important foregoing philosophies. However, I also accept that the parameters describing the net-nets were derived through regression analysis in the 1930’s. Such analysis undertaken today would provide a different set of metrics describing a safe investment.
In fact, I am reminded of another approach to defingin financially strong companies. A similar approach using regression analysis is used to answer what are the ratios that are common to compinies that have failed? The complement of these is a good starting point for determinng financial safety.
So, a good debate over the process, but never lose sight of the principles. They remain pertinent today and especially in March of last year.
admin
:
Hi Tony,
…and perhaps in May of this year! Thank you for your insights Tony. A well thought out reply.
peter care
:
I recently read Alice Schroeder’s The Snowball, her excellent biography of Warren Buffett. As I was reading it, you could see the change in Warren from Ben Graham’s looking for cigar butts approach to be more in tune with Charlie Munger’s willingness to pay up for good businesses. Some of Warren’s worst mistakes was when he bought a poor business because they were cheap. What surprised me for example is Buffett even bought an airline because it was cheap (and lost money). I don’t usually like biographies, but I couldn’t put this one down.
admin
:
Thanks Peter,
Quite a tome isn’t it. The path from Graham to Munger has thus far been understated in much of the literature about Buffett.
AndyC
:
Hi Roger,
I don’t know if you recall an earlier comment of mine describing Graham and Fisher being on my shoulders. I thought you would be very interested in reading this piece by Jeremy Grantham.
It is one of those examples of a piece that matches perfectly with sound reasoning something that was merely a strong intuition in my own mind. I agree wholeheartedly with his point of view. I know that your brand of ‘value investing’ has at it’s core return on equity, so I’m presuming you might also agree with Grantham’s analysis?
Cheers,
Andrew
http://www.scribd.com/doc/30409658/Jgletter-All-1q10
Luke
:
Hi Roger,
Thanks for the insight. I have only just entered the share market and made some stupid mistakes already. I am currently reading a few books about Buffett and I plan to read Graham and Dodd’s book next, followed by yours.
I like this post – it really emphasises that you need to look at a lot of factors, not just one (P/B ratio in this case?). Also, I think you were very diplomatic in the way you have written this post. Good work!
I am really looking forward to your book. I guess it is coming out in May?
admin
:
Hi Luke,
Thanks for that. Yes. Getting very close.
Manny
:
Roger, a lot can be said about intangible value/Goodwill. Some of the best companies have a high amount of goodwill and very little tangible assets (as you rightly pointed out). WB likes companies with strong brand power – the goodwill grows overtime but is not necessarily reflected on the balance sheet.
If you were to use a variation of value investing to buy 30% below Net tangible assets (NTA) you probably would end up with a list of capital intensive dogs. I doubt there would be many opportunities to buy quality business below Bookvalue let alone NTA (which excludes intangibles) You can of course make money purchasing these types of businesses, there is all kinds of ways to make money (including technical analysis). I sleep better though, owning and holding on to the best companies and over time getting paid good dividends for the privilege.
I have read and own the Intelligent Investor. To me reading this book was the best place to start but also read Buffett and Lynch books. I agree with another post that the content is timeless, although not all of it was relevant (particularly the part on bonds).
A limitation to the Graham method though is selling out, how can one make the big 10 or 100 baggers if you sell out. That’s what Buffet recognises and he even talks about some of the companies that he owns that he would never sell, at any price.
I wouldn’t limit myself to Grahams approach though. Peter Lynch was fully invested for 20 years and his fund did very well 29% per year over 20 years which included the 81/82 and 87 crashes. Speaking of books when is ValueAble available. I think we are all keen on reading that one too!!!
admin
:
Hi manny,
Couldn’t have said it better myself. Thank you.
Ashley
:
Hi Roger,
Thanks for your thoughts,
Your oil and gas expert Lloyd mentioned ITX in a past post and you said you were taking about it last week.
I have gone back a few weeks and I can’t find any mention about this stiock on this Blog.
Can you point me in the right direction?
I have had a bit of a early look at this stock and it is worth a second look.
My only initial concern is the apparent declining margins. Can you or Lloyd expain why this is not a problem?
Thanks again
Lloyd Taylor
:
Roger,
One poster, Ashley, asked about ITX’s declining margins asking “Can you or Lloyd explain why this is not a problem?”
It is your blog not mine and I don’t wish to steal your thunder, so I leave it to you to decide whether you want to post this reply in some form on your blog.
Net profit margins (NPAT/Sales) in the last few years have bounced around in the range 4.6% to 6.4% with 4.9% in 2009 so I see no issue here given the state of the economy in 2009. However, ROE in 2009 was depressed by virtue of two acquisitions early in the year which saw equity in the business rise by 23% and more importantly goodwill rise by 178%. This occurred in a slowing economy with depressed sales growth. The result is that ROE declined YOY from from 46% to a still healthy 38%. Based on the interim 2010 result and the outlook for the balance of the financial year, I expect ROE to climb back above 40% in the current year. So no permanent trend of decline in ROE, but rather a temporary decline as a result of a couple of acquisitions which will gather their straps in coming years, if not months.
The explanation is qualitatively explained in layman’s terms in the Chairman’s and Managing Director’s commentary in the 2009 Annual Report (pages 3-4 of the report).
Use this reply, or otherwise, as you see fit.
Regards
Lloyd
admin
:
More than happy to delegate! There you go Ashley. Thanks Lloyd.
Ashley
:
Thank you LLoyd and Roger,
I was actually looking at gross margins which in the half year report declined from about 25% to about 21%. I have not done enough research to see if this is a good thing or bad but sometimes it does reflect increasing competion.
However, declining margins for say a Walmart or a Jb Hi Fi have been a way of gain more dominance in their sector.
Thanks again
admin
:
Thanks Ashley,
The bigger question you raise is whether there’s a competitive advantage here that is valuable (one of the reasons for the title of my book Value.able). The guys here are looking at ITX and the question that keeps coming up is what is the sustainable competitive advantage? Can the business double, triple, quadruple its equity and maintain its returns? ALternatively and arguably preferably, can it keep its equity the same and double, triple and quadruple its profits? Find the answers to these questions and you have the answer to the margin question you ask.
Ashley
:
Thanks Roger,
As Darryl Kerrigan said in the Castle “I wish I had your words”
Jared
:
Roger,
I’m glad you took a stand. I think people get too caught up with the idea of intrinsic value; it is purely a guide to what the right price should be for a businesses.
I would definitely say im not a person who invests using the ‘value’ approach. Whilst understanding the merits of business valuation, valuation methodologies only provide a guide to the actual intrinsic valuation of a business because they’re so dependant on the inputs.
If people become too blinkered with the idea that they’re buying something below net assets or its intrinsic value, they fall into the trap of buying ‘crap cheaply’.
quality is the way to go.
admin
:
Hi Jared,
Thanks for the thoughts. I should clarify that I am a staunch proponent of buying below intrinsic value. I do however believe that one should only bother valuing great businesses. Think about Buffett’s famous and well-worn quote: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Sums it up perfectly.
Steve Moriarty
:
Hi Roger,
What a timely post! Personally I have 2 portfolios – one is a “net nets strategy” and one is a more Buffett.. dare I say it Montgomery approach. I chose these approaches because I was not sure which delivered the best returns. Greenwald appears to favour the Graham and Dodd approach and Buffett has stated that if he had smaller amounts to work with then he could make more money – I assume he says this because he means that he could buy smaller cheaper “net nets” type shares rather than been limited by the large amounts of capital that Berkshire has to invest.
Over the past 3 years, I must admit that the net nets have appealed to me because it is in many ways more “exciting on a day-to-day basis (I’m a full-time investor) due in large part to the volatility. But the Buffett/Munger approach has been much more successful at this stage (since buying in March/April 2009).
The problem I find with a net-nets approach is that it takes me into the “worry” zone. I never worry when MMS, JBH or CBA decline in price but when the net nets do, I start to feel an urge to sell. I believe this is because many of them have little in the way of trading history and as such their intrinsic value and earnings capacity are somewhat unknown. Much depends on “the market” and looking for the catalyst to “realise the value”.
I decided late last year to gradually shift away from the net nets and seek more Buffett style investments. This may be a function of my age (47) but it appears that Buffett style investment do truly allow you to sleep at night.
regards
Steve
admin
:
Hi Steve,
Fantastic to hear that you have been running both approaches and I am not surprised to hear that you have reached the same conclusion. When Buffett talks about being able to make 50% returns if he was starting again, you may be right. I also believe that he is referring to the many small opportunities available that can make a serious impact on a smaller amount of capital but make no debt on the many billions he now manages.
JohnC
:
Looks like Warren guessed wrong in 1993 because 16 years later, in March, Graham’s approach would have worked better than where many others would’ve fled into either quality or cash. I imagine that value investing is about building up a mental toolkit to fit different problems and scenarios. Warren’s Munger-inspired quality approach works best when one is investing in a bull climate with billions of dollars whereas Graham’s approach is for those times when almost everyone is proclaiming the end of modern civilisation and one has at least some dollars dollar of cash to invest.
admin
:
Hi John,
Good thought. I can however attest to the benefits of buying the best quality businesses below intrinsic value in March 2009. I don’t disagree that both approaches afforded ample opportunities in March 2003. Remember not to ever forego the opportunity to buy wonderful businesses because of short term concerns about the economy or the market.
Craig
:
I bought The Intelligent Investor 4 years ago after reading an article on Buffett in a Financial magazine. I read it solidly – skipping over the parts on Bonds – up until February last year when I bought my first direct shares.
IF nothing else, it was the message distilled in “Be fearful when others are greedy, and greedy when others are fearful” that encouraged me to buy when I did. Those investments are up 200%, so don’t anyone be too unkind to Ben Graham. I love that man.
The real value of the book is in driving the message home about using valuations, market fluctuations, prices and how they compare to valuations to guide your decision making, rather than the speculative approach that seems to be most popular. Even if, like me, your valuation methodology is a work in progress, just understanding that there is an approach that makes so much sense – buying shares when they’re cheap, not soaring in value – can be enormously helpful, and enlightening.
The concept of buying something worth $1 for 50c can be illustrated both by a Graham Net-Net, and a Charlie Munger growth stock, as a purchaser believesthat at some time in the future his purchase will be worth more than it is now – fair to say a speculator does too but his reasoning is usually ALL qualitative andnot quantitative.
Just two days ago I walked into the Investing Bookshop on Collins Street and bought a new edition copy of The Intelligent Investor for a friend who actually has worked in the Finance industry for some years but has never been exposed to this seminal work. I think its a great present, even if I do say so myself.
I will say this about Ben Graham though, regarding his writing. Finance is a dry argument at the best of times, but Graham is not what I’d call a light read, even if The Intelligent Investor is supposed to be ‘Security Analysis’ watered down for laymen. By comparison Buffett’s writings are a joy (it’s really hard not to like that guy). Phil Fisher? Someone needed to give that man a Strunk & White.
The principals in The Intelligent Investor are timeless, even if the content used to illustrate them is dated, and I won’t hear a bad work said against the author.
But I may be biased.
Roger, are you in Omaha this weekend?
admin
:
Hi Craig,
Thanks for these points in the affirmative. You raise some valid and reliable arguments. I have a few friends in Omaha this week but I declined my invitation. Too much to do and I have to admit to preferring the Wesco AGM in Pasadena – there’s also a couple of really great bicycle stores there.
Chris
:
Roger,
I noticed one of the posters asked if you were going to Omaha for the Berkshire Hathaway AGM.
I have to say, not disparaging Warren or the valuation methods, but it really makes me cringe when I hear it being talked about in the media as a ‘pilgrimage’ or to see people say “I’m a Buffett Disciple !” when they’re standing in the local branch of Dairy Queen after the AGM. I saw a recent BBC documentary – “The Worlds Greatest Money Maker” – where they were doing exactly that. It was saccharin sweet….and just as fake.
It just seems so ‘groupie’ to me, that some people (the real, long term investors) will go because they are genuinely, deeply interested in what he has to say and his viewpoints, but some are not necessarily there for that – they are there to try and prove to everyone else ‘just how big a fan they are’ and that they’ve read ‘all his books’ (the irony is, of which I don’t think he penned any of them ?) and they quote him endlessly.
When Alice Schroeder said what she said in Business Week recently, I thought “Wow. I am not the only one !” She described it as a circus.
When the sharemarket turns, these faux ‘investors’ are the first to leave and never come back. It’s like a music concert or a football match. You go there to enjoy the music / sport or you go there to show off how much you love the band / team.
For me, I never will, and never want to own any A or B share in Berkshire Hathaway. I don’t hate Buffett, I don’t care about his investments or ethics behind them, the controversy over GEICO (someone told me today that what else is their business based on, except derivatives) or Goldman Sachs – I don’t care. I just can’t be bothered ‘joining the cool gang’. I love the USA, but I would not go there for ‘that’ AGM.
The other supreme irony is that Buffett said that you can’t expect to do well in something when everyone else is interested in it, which is what this kind of has become. I bet it has lost some of the fun from the early days, or even 10 years ago when he was denounced during the dot-com era as being a “stupid old man who had lost his touch” and only the die-hard investors backed him.
It’s kind of like if Argo, Choiseul, Milton went and became too popular and everyone knew about them, or when a stock becomes a market darling. It sadly loses some of the shine, because now everyone knows about ‘the secret’.
admin
:
Hi Chris,
I was told of a story that everyone might like to read on Bloomberg. Its written by Alice Schroeder. I am not sure if it is the same Schroeder who wrote Buffett’s biography ‘Snowball’. If it is then its telling because she writes a rather dim account of Buffett and the AGM. The article is entitled Buffett Turns Into One More Corporate Bubble: Alice Schroeder and it can be found at
Here is an excerpt: “The meeting has grown into a circus populated by television commercial characters come to life, a model train set, and people dressed as giant foam bricks. It is a product, one sold mainly to people who want to experience the novelty of being in Buffett’s presence. Its highlights are broadcast instantaneously on TV, so for everyone else, the point of being there is to buy discount underwear at the Fruit of the Loom booth and have your picture taken with the guys in fruit suits”
Lloyd Taylor
:
Roger,
I think that you’re absolutely correct to assert that the world, business models and the market have moved on to the point that Graham’s valuation approach is close to irrelevant. However, as you note the principle of buying with a margin of safety remains as relevant as ever.
The key is to determine what is the margin of safety in any investment decision?
From my perspective this involves consideration of a range of business outcome projections and consideration of the risk that these outcomes will be realized. In effect a quantified scenario approach to valuation which delivers a range of value and associated probability of realization. With this range of valuation one can make a buy (or sell) decision, knowing how far out on a limb the purchase takes you and with the knowledge of what signs or critical milestones to look for as to where on the valuation range things are headed with time. That said I never buy the upside valuation (on which the vast majority of Australian stocks are priced). For me the odds have to be far better than even that the business outcome will be realized and it is this that the margin of safety is found.
This means active business outcome valuations (plural) and continuous monitoring of business performance to mitigate the risk. As for buying below book value…. in my dreams only does this occur (at least in any business with quality and integrity).
Regards
Lloyd
admin
:
Thanks again Lloyd. Very much appreciated. Multiple valuations are something I have referred to here previously. Regarding buying below net current assets or even below book value; There were a few examples in March 2009 but it does seem that you need to the economy and the markets to be standing at the precipice to obtain those opportunities.
Ashley
:
Hi Roger,
Thanks for your thoughts,
JustI like to say that if you invest like Ben Graham did in Australia you would hadly ever buy a stock and if you did they would not be the quality ones
As you say the US and even more Australia has become a service nation with comapnies like JBH and TRS of little or no value to the “intenigent Investor” Like Graham. Yet these are great businesses.
Times change and valuation methods must change with them.
Look forward to the book
admin
:
Thanks Ashley for your kind thoughts.
Geoff
:
Hi Roger,
Great article.
I note that Jeremy Grantham discusses and compares a Graham approach to a quality emphasis in his latest letter. You can download this at the GMO website. He has very interesting insights into these two approaches.
Regards,
Geoff
admin
:
Thanks Clayton,
I will do exactly that!