The “Value Investing Way” Part I
Are you an investor or a speculator when it comes to the companies you purchase stock in? To answer for myself, in most of my early twenties, I was more of a speculator than an investor, though I would certainly tell someone that “I was investing my money.” I would spend my day looking at stock charts, ticker symbols, and glued to every up and down tick of the stocks I owned or wanted to buy, thinking that my ability to predict stock movements was the way I would grow my “investment.” I would read blogs and news articles about a new start-up company or penny stock that was sure to go up in value by 100% within the next week. I bought companies that had no earnings, an unproven product, and the only thing to their name was a “story.” Needless to say, I made no money my first few years of investing. Fortunately, I did not lose any money, but after two years, I would’ve been better off putting the money in an FDIC insured savings account at the bank. My strategy was not working, and I either needed to quit or find a new strategy.
I decided that instead of quitting, I would search out a new strategy and approach. I cannot remember the exact article, but during my research I came across an article written about Warren Buffet and his timeless approach to investing. As I read through the article, I remember thinking that it was obvious Warren Buffet was a very successful businessman, but yet the author seemed to indicate that Buffet’s approach to investing is very different than what the media portrays the investing world to be. When most people think of investing in stocks, they think of people yelling and screaming on the floor of Wall Street, Jim Cramer’s obnoxious show, and even worse, they think of the movie, “The Wolf of Wall Street.” The fast paced world of investing depicted by the media that people get sucked into is what makes money for everyone other than the “investor.” There I was, reading through the article and learning that Buffet bought companies in the 1970’s that he still owns today, and how he very rarely makes purchases or sells, and thinking to myself that this was far different than what I've learned in the past. Needless to say, this got my attention.
Now that I had some direction, I began researching everything I could about Warren Buffett, especially his earlier years. I found out that he was taught by a professor named Benjamin Graham at Columbia University, who Warren Buffett refers to as one his most influential mentors. It turns out that Benjamin Graham is known as the “Father of Value Investing,” due to his pioneering academic work in creating formulas and strategies that help an investor place a “value” on a stock. This approach of placing a “value” on a stock is known as “value investing.” Value Investing is in stark contrast to my former approach of “day trading,” which caused me to totally rethink how I viewed investing in stocks.
With an even sharper direction now that I had an actual investing approach to research called value investing, things began to become clearer for me. The value investing approach looks at stock ownership as becoming part owner in a business. Instead of looking at a stock as a ticker symbol that moves up and down, value investors look beyond the stock’s ticker symbol to the underlying business itself that produces a product or service. When you buy a stock or share in a company, you are becoming part owner of that company whether you understand it or not. Depending on how many shares the company issues and has outstanding, and how many shares you buy, determines your percentage of ownership. For instance, if a company has 1,000,000 shares outstanding that investors throughout the world have ownership in, and you own 100,000 shares, you own 10% of the company. That means your portion of the company’s earnings and dividends is equivalent to 10%. I began to understand that owning a stock in a publicly traded company is not really that much different than having minority ownership in a private business. Suddenly, investing became very businesslike. In fact, it was Benjamin Graham that said, “investment is most intelligent when it is most businesslike.”
Now that I knew buying a stock was the same as buying partial ownership in a business, it was obvious that I should only want to own a good business and I needed to learn how to identify them. As I began to research the value investing approach to determining a good business, I came across numerous qualitative and quantitative characteristics that make for a good business. On the qualitative side, an investor should look for a company with good management, be in an industry that provides a product or service that is deeply tied into our human nature, has a competitive advantage, and displays a history of rewarding shareholder’s through increased dividend payments or efficient capital allocation. On the quantitative side, an investor should look for companies with consistent increased earnings, low debt to asset ratios, and a high return on shareholder’s equity to name a few.
It was slowly coming together. Even though I learned a few of the basic things to look for in a company to be a good investor, I found out that you must also know what is a good price to pay for a company, as that often determines the return of your investment. I will save this piece of the “value investing way” for part II in this series. I hope my experience will help some of you on your way in becoming more intelligent investors and look forward to your feedback or questions.
Founder of Vintage Gentlemen
*Please note that no information in this article should be taken as investment advice to buy or not buy a particular stock or other investment.