It’s been proven over decades by some of the sharpest money managers on the planet, who’ve used it to become incredibly wealthy. And, like most things that have stood the test of time, it’s based on good old-fashioned common sense: its central aim is ‘to not lose money’.
You don’t have to understand anything tricky – like the latest breakthrough technology or Kim Kardashian’s marital status – or be able to predict where the share market or the economy is headed (leave that to dart-throwing monkeys, who, repeated studies have shown, are just as accurate as the highest paid economists).
All you need to do is to embrace a strategy called ‘value investing’. It essentially involves being an investment tightwad – looking for good-quality, easy-to-understand businesses that for one reason or another have been beaten down by the share market.
Warren Buffett is the most famous value investor and he explains it like this: “Your goal as an investor should be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher 5, 10 and 20 years from now … and when you see one that qualifies, you should buy a meaningful amount.”
I know what you’re thinking: “Dude, I’m not Warren Buffett.”
I hear you. But in a fascinating article called ‘The Superinvestors of Graham-and-Doddsville’, Buffett convincingly argues that the extraordinary returns people have achieved through value investing is anything but pot luck.
The people who studied under the ‘grandfather of value investing’, Benjamin Graham (author of The Intelligent Investor), went on to make their investment fortunes applying his formula.
Buffett introduces Walter Schloss, a man with little education, no computer and no employees, who from 1955 till he retired in 2000 reportedly achieved a 15.5 per cent compound return. (So say if he started with $10,000 in 1955 he’d have turned it into $5.3 million by now.)
When asked to summarise his approach, Schloss said: “I just try and buy cheap stocks. I don’t like to lose money and so if I buy them cheap enough I’m effectively protected on the downside … and the upside takes care of itself.”
So what sort of companies do value investors look for?
Nothing too exciting: no tech stocks, resource companies, or startups. Instead they look for companies that can be counted on to keep making money year in year out – the more boring the better.
That’s one reason Buffett has favoured consumer staple companies like Gillette razors: a few billion blokes wake up and need to shave each day. Another, as I’ve mentioned recently, is Coca-Cola. These are both strong companies whose earnings are stable. Let’s face it, Schick is for chicks, and have you ever walked into a pub and ordered a bourbon and Pepsi?
So can we all be super value investors? Probably not – if it were that easy we’d all be on a beach (with Kim).
Yet the central tenet of value investing − looking at share market slumps as an opportunity to buy well-run, debt-free businesses that you understand − is the safest way I know to not just successfully manage your investments, but to sleep easy at night.
Better value elsewhere
Looking at what’s going on in Europe right now, we may not have to wait long for another crash on the market. But don’t get me wrong − value investing doesn’t mean you should go out and kiss any old frog. Here are three investments that don’t currently fit the bill for value investing.
I almost feel un-Australian for saying this, but right now resource companies aren’t the place to be if you’re looking for safety and security.
Unlike the Australian Government, which takes ever-increasing growth for granted, smart investors understand that mining is cyclical. Booming resource prices mean our miners are currently making a motza, but this is completely dependent on the Chinese continuing to pay top dollar. While the rise of the East is the investment story of our lifetime, any shakeout along the way will be reflected in the miners’ share prices.
Another ‘value trap’ investment is television media companies. This week Kerry Stokes made headlines when he said “the banks will own” the Nine Entertainment Co within the year, a reference to the crippling debt the company is under as a result of the leveraged buyout a few years ago.
Before the internet, television was a fantastically profitable business (which explains Kerry Packer’s love affair with Nine). Big-budget advertisers who wanted to really hit the masses had three choices: Seven, Nine or Ten.
They’re still fierce rivals, but the real competition is coming down the tube. In the next few years consumers will increasingly work out that the oversized box sitting in their living room is really a giant computer with millions of channels that advertisers can use to pinpoint the exact person to market to.
Case in point: YouTube has announced a move away from videos of fluffy cats and free hugs, spending $100 million on brand new content for its newly created ‘channels’, which will be accessible free anywhere in the world.
The final place I wouldn’t be investing in is discretionary retailers like JB Hi Fi, Harvey Norman, Myer and David Jones.
It’s been years since I ducked in to JB to buy a DVD, and the last time I was in Harvey Norman looking to buy a fridge I was comparing prices on my mobile. (Don’t give me that look − you do it too. This week Google reported it had seen a 220 per cent year-on-year increase in retail queries over mobile phones.)
One last thing for those of you who are spooked by the debt-fuelled disaster in Europe: Bloomberg is reporting that Warren Buffett’s Berkshire Hathaway invested $23.9 billion in the last three months – the most in at least 15 years. The last time Warren invested more than $20 billion was in 2008, at the beginning of the financial crisis.
“We’re ready to buy lots of things”, Buffett told Bloomberg. “If the stock is cheap, we will buy it.”
Tread Your Own Path!