RIP - Value Investing

The term "value investing" is one of those words where the more you think about it the weirder it becomes.  What is value after all?  It seems anything can be value investing, because value is in the eye of the beholder.

Security Analysis author Benjamin Graham made the comment in his book Intelligent Investor that

"Investment is most intelligent when it is most businesslike. It is amazing to see how many capable businessmen try to operate in Wall Street with complete disregard of all the sound principles through which they have gained success in their own undertakings. Yet every corporate security may best be viewed, in the first instance, as an ownership interest in, or a claim against, a specific business enterprise. And if a person sets out to make profits from security purchases and sales, he is embarking on a business venture of his own, which must be run in accordance with accepted business principles if it is to have a chance of success."

Let's take a step back for a few minutes.  One of the most basic rules of business, if not THE most basic rule is you sell your products for more than it costs to create or obtain them.  This is simple.  If you are going to open a ice cream shop where your cone has $.25 worth of ingredients and $.50 worth of labor and rent in it you need to sell it for $.75 if you want to stay in business.  This concept is so simple that even children understand it.  Have a child purchase an item for a few dollars and then ask to buy it off of them for less than they paid, they'll protest.  It simply makes sense.

Unfortunately this business logic doesn't extend to the stock market.  Our fictitious ice cream shop selling cones for $1.00 that cost $.75 would trades for less than the trendy ice cream shop selling the same cones with the same cost structure for $.50.  Why is this?

In the stock market there is a second dynamic at work, it's investor psychology.  It isn't just what the underlying business is doing, it's what other investors are willing to pay.  In our example investors prize trendiness and losses over profits, and so they are willing to pay more for company B.  Of course there will be stories explaining why B is better than A.  The psychology is that investors feel that since they love company B that everyone loves company B and they will always be able to sell their shares for more than they paid.

Maybe company B will make it up on volume, or they're growing, or they have a visionary ice cream scooper.  The reality is unless company B raises their prices, or figures out a way to lower their costs they will eventually end up out of business.

There is no magic to this, it's simple math.  And when you argue with math you lose, every, single, time.

Sometimes value investing is described as buying unloved companies.  The story goes that the value investor would purchase company A in our example because they aren't as trendy, or as popular.  If you extrapolate this idea you end up with the idea that a value investment is just a piece of unpopular garbage, or something no one else likes.  I think it's neither.

There is another way to view a value investor, they're an optimist.  Someone who looks at the ugly duckling and says "Hmm, they're still a duck, they can still swim, walk, fly, do duck things.  If other ducks are valued on duck things the ugly one should be as well.  And besides, beauty is fleeting, maybe those beautiful ducks will age out over time.."

Or let's take another analogy, sports.  The market values the MVP's (most valuable player) of the team.  They are popular, have great stats, and do well every game.  How could you not like the MVP?  The value investor looks at the teams that are doing poorly and works to determine which underdog has a real chance.  They're looking for the upset team, or the breakout star.  Sure that underdog might only win a game or two, but if you're gambling on single games picking the underdog will result a bigger jackpot.

The optimist isn't stupid, they don't buy what's unloved just because it's unloved.  They buy it because after evaluating the circumstances they've determined that a company has a chance.  There's a reason to be optimistic about the future when everyone else is pessimistic.

Value investing is difficult because it's hard to be optimistic when everything looks bleak.  It's easy to be a growth investor because everyone is optimistic and you're optimistic along with them.  

Unfortunately at this juncture in the market value investing is dead, completely dead.  The reason is there is almost nothing that people aren't optimistic about.  

My view on this was crystalized when I spoke to a client earlier today who specializes in small rural banks.  They said that what they're seeing is unbridled optimism about economic expansion in places that haven't been optimistic since the post World War II boom.  When optimism has crept down to the sleepiest of places it has become persuasive.

Of course a retort to this post is that there are still 'cheap' companies.  There will always be companies with struggles or issues, and dying industries.  But the caveat is sometimes the market's pessimism is justified.  Industries die, companies die.  Sometimes a dying company is simply a dying company, not a value investment.  A value investment is a company that looks like it might be dying but it isn't.  Or one that the market has left for dead that is going to survive.

When I look at the market, both the public market and the private business world I see optimism everywhere.  That's a good thing, but bad for a value investor.  It's bad because there aren't things that look bad to be optimistic about.  At this point being optimistic is simply running with the pack, everyone is optimistic.  If the future optimism is warranted then everyone will do well.  Maybe we'll finally usher in that period where stocks reach the ever illusive permanently high plateau.

Given the current situation an investor has two choices.  Cheer for the star players along with everyone else, or sit on your hands and wait.  I'm more comfortable with waiting.  The good news is this, when opportunity finally arrives it will be here for a while.  The last time the market crashed there were still eye-popping bargains four years later.  You didn't have to get in right away, you could have sat on your hands for a while and still done well.

If you want to invest with the market buy something, anything really, it will go up.  For those who prefer to be optimistic in the face of pessimism there are always a few companies in little nooks and crannies, but not much else.  Maybe it's time to take a long vacation..


  1. I struggle with this question a lot recently, are market values high because we are in a mania or because of interest rates being low. I have started to conclude those who invest in these ice cream companies you mention (no names ;) ) justify their purchase by saying interest rates are low. You can find pockets of cheap stocks that are looked at as "old economy" like brick and mortar retail etc. But in the end most asset prices are high, real estate prices on an inflation adjusted basis is at 2005 levels, 107 million auto loans are outstanding with 85% of cars being financed while auto makers are making near record all-time profits. Debt hasn't been reduced, its just been shifted to businesses and the public sector, these companies take on debt lowering their shareholder equity thus increasing their ROE giving the idea that they are somehow doing well but this isn't justified by their ROA. It seems as though some large companies are not longer making investments with the idea of what that investment will return and the cost of the debt or equity to make that investment. We also have this idea that we are somehow out of the woods economically when its far from the truth, savings as a percentage of disposable income has been falling and now sits at just 3%, yet we have seen net worths as a percentage of disposable income reach the second highest its ever been, only being beaten by 1929.

    The overall environment is nothing to get excited about yet it seems the general public is.

    1. I have had similar thoughts. Part of me thinks this is similar to the late 90s, it has the same feel. The other half thinks that maybe this is more like 1981 and we'll just continue higher with little downdrafts. I don't know.

    2. I believe that valuations are high, because interest rates are low. Interest rates are the gravity for asset prices.

      See Warren Buffett's statements on this topic:

  2. Sorry, but I found this to be a really poor article.

    Value investing I think has never been stronger, I just think the nature of it has changed. Growth can be value, and I think Warren Buffet got this earlier than most of the value guys. I do however think the general investing community has finally started to wake up to the importance of high quality growth companies, the compounders. I think because the nature of investing has changed, it necessitates this this very logical shift in investors thinking. We are in an unprecedented era for the destruction of old line business models. Too many of the traditional value guys are getting pulled into these old line value traps because they look statistically cheap. Instead they should be willing to pay up for the high quality growth companies with excellent economics, a moat and a runway where they can do their magic.

  3. Your comment presents a simplified and misleading narrative. You are wrong about value investors only recently "wak[ing] up to the important of high quality growth companies." Philip Fisher's "Common Stocks and Uncommon Profits" was first published in 1957! Buffett (two Ts!) has been talking about buying high quality companies for decades. How many thousands of students have gone through Columbia's value investing program and listened to Bruce Greenwald pontificate about the importance of terminal values to valuation? Nearly every value investor on Twitter's "#fintwit" appears to be a GARP-type investor. In sum, I think sophisticated value investors have been very aware of the factors you cite for a long time.

    You also seem oddly unaware that there is plenty legitimate room for disagreement about which companies have long growth runways, and which are in terminal decline. Sophisticated and well informed investors operating with the same basic value investing playbook can and do have widely varying opinions about the prospects for particular industries and companies.

    It's easy to create a tidy narrative to justify your investing beliefs and biases, but the truth is much more complicated.

  4. Great article, Nate. I've noticed a disturbing trend recently of people who have been successfully applying a Ben Graham style of value investing switching over to a so called Munger style. On the surface, of course, there's nothing wrong with this, but the number of people who can successfully apply the great company at a fair price approach is very small. Call me a cynic but what I see are people unwilling to sit still.

    Out of curiosity, what % are you cash at the moment?

    1. Thanks. I'm about 40% cash right now.

    2. I am totally open to the idea of the "100 bagger" school of investing. However, this is a fairly difficult strategy to implement compared to the shooting fish in a barrel that is bargain hunting. I'm still finding bargains but not necessarily high quality bargains. I would love to buy say Brown Forman or McCormick at 12x or less earnings and would consider putting a massive portion of my portfolio in them but as it is I'm buying crazy companies that most people wouldn't touch with someone else's ten foot pole.

      Also when one goes through the pages of, "100 baggers," or "100 to 1 in the stock market," and others: it's illuminating to see some of the plain Jane type of businesses that can make you rich. It's not all Microsoft and Google, in fact, it's mostly not tech companies at all that have historically proliferated the 100 bagger lists often because tech companies are almost always too popular to be one of the great investments of all time.

  5. Great Post! There are still some value investments out there but they have become very few at current valuations.

  6. It's really hard to predict how, when, and where opportunity will arrive, and how to get prepared, and stay prepared, to take advantage of it once it does. In any case, I always like holding a large percentage of cash, but especially now.

    I have turned my attention 100% to operating my business. It's a good time to operate a business here, taking advantage of the almost euphoric optimism.

    When I feel like saying, "I've been patient long enough, dammit!" I ask myself, why do we value investors deserve once-in-a-lifetime investing environments more frequently than that?

  7. Welcome back, Nate. Your good common sense has been very much missed. Good article.

  8. It's getting harder and harder to find decent deals.

    And when I have found them, each has been more of a 'unique' situation. Usually it's been companies selling at 20 PE with unusually good re-investment opportunities, or with easy growth so all the cash is 'free-cash'.

    For instance, in late 2015 it was EBAY (and a couple of others). EBAY is a company that takes very little cash to run, so with a functional PE of 20, you'd get 5% free-cash for buy-backs or whatever. This meant that even slow growth of low to mid digits would ensure a good return on EBAY stock over time.

    And for the last several years, the 'permanent capital' type operations (BRK, MKL, a little Y) have been a reasonable value.

    But recently, it seems that the EBAY's of the world, which took some insight to even recognize as decent investments, are all up 30-50%. And the same is true for things like BRK. I'm still 80% invested, but I haven't found anything new to deploy money into.

    It's a tough market for sure.

  9. While we may be late to the comment party, we are still finding some suitable value in equity entrees in the all you can eat buffet style market. Our experience differs from that of most value investors we read from or personally know as they are typically not searching and uninterested in the core sector we specialize in - software and tech.

    Indeed, Graham style value investing was developed based on avoiding losses Ben witnessed during the Great Depression amongst the backdrop of an industrial economy.

    So it is no surprise many value investors are averse to using a non asset based valuation methodology. Yet this is one of the few places left where value is being unlocked.

    Be clear - we are still patient investors, must find underfollowed, illiquid and unloved companies, need to stay within our circle of competence or otherwise find ourselves in no man's land, and manage the investment cycle tactfully as we are generally buying during the distribution (and hopefully capitulation) phase and not too early.

    Price volatility may be high, yet as Marks states volatility does not equate risk and may be a value investor's friend.

    Nevertheless, we journey on identifying the 'cheapness' factor (as opposed to cheap prices) narrowed to a handful of high conviction ideas while harvesting gains as a sell thesis is achieved. Pivoting beyond equities to alternative investments, holding cash, and owning index shorts against the portfolio (a source of funds in a selloff) is the ongoing modus operandi.

    Uncertainty prevails. Though we remain in this market cautiously knowing other investors are statistically complacent and market valuations are high on all relative metrics. We entered the year assuming underperformance given our positioning.

    Such is the life of a value investor.