The Mind, Method, and Money of Value Investing
On 29 May 1953, Sir Edmund Hillary and Nepalese Sherpa mountaineer Tenzing Norgay became the first people confirmed to reach the summit of Mount Everest. 1953 sees the achievement of a long standing challenge to humanity, the conquering of one of the most elusive places on earth, the summit of Everest. At the same time 1953 marks the beginning of another monumental journey of achievement. It is the start of one man’s mission that would ultimately lead him to become the greatest investor of all time. It is the year after Warren Buffett finished studying under Benjamin Graham at Columbia University and just prior to him starting at Graham-Newman Corp. as a security analyst.
Ask Warren Buffett how he achieved his phenomenal success and he would say it is really simple and does not require any extraordinary mental abilities or special talents. In fact, he distils value investing down to four simple steps. He says you should find simple businesses, with good management in place, that have a durable competitive advantage, and that poses good economics. It sounds simple enough doesn’t it? However, to achieve Buffett’s success following these four simple steps would be like telling someone to put on some warm clothes, pack a backpack with food and drink, and to climb Everest successfully. Simple enough to understand, but an altogether daunting task! So what does it take to reach the summit of value investment? Mental abilities and special talents already discounted, by Buffett himself, value investing therefore surely has to require some other character traits? Fortunately there has been, and are, many others that have achieved great success as value investors allowing us to identify the common elements and approaches to success. The commonalities among value investors all stem from a single source. Value investing’s Edmund Hillary is Benjamin Graham, aka the dean of value investing. Graham established value investing as a formal approach to investing in the 1930s. The approach, methods and advice he developed has helped many followers achieve extraordinary success. Graham focused on two main elements of investing: the mind of the investor and the method of investing. Successful mountaineers will all attest to the fact that you first need the right psychology, the focus and perseverance, to be a successful climber. Similarly, Graham shared this belief and continuously encouraged investors to develop calmness, rationality of mind, and perseverance to be successful. He vehemently warned investors to guard against the perils of two of our most basic of human emotions, fear and greed. He said that the market will use both fear and greed to draw you in, hype you up, and cause you to react irrational at the best of times. Investors, like mountaineers, cannot afford to behave irrational because it will likely cost them their lives. The determined, patient, rational, and often contrarian mind is developed by focusing on buying quality companies and holding them for the long term. A long term focus allows value investors to use the market to serve them and not to instruct them, allowing them to ignore most market fluctuations and hype. The second element of Graham’s teachings relates to the method of value investing. Method is all about finding quality businesses to invest in, and here Buffett’s four simple steps become relevant. Over the years different value investors have developed slightly different valuation approaches to identify businesses presenting great investment opportunities. However, common to all is the focus on the value of the underlying business or asset and the quality of management rather than a focus on market prices or price movements of shares. Some value investors measure the value of a business by focusing on the income, or cash, generated by the business. Others consider the balance sheet of more importance when valuing a business and thus focus on its assets. Irrespective of the specific method used to value a business, a value investors’ approach is to hunt for great businesses at great prices. Any experienced value investors will tell you that price is what you pay and value is what you get. Finally, there is also something I like to call the money element of value investing. This is often the most overlooked element, but I believe very important, to make a great value investor. Buffett’s own lifestyle, his approach to the use and application of his money, is a good demonstration of money management, the final element. Buffett’s lifestyle shows that value investing becomes more than an investment approach. It is rather a way of life. True value investors understand the difference between having lots of money and managing your money to work for you towards wealth creation. One is about having more in order to spend more. The other is about patiently collecting more toward achieving financial independence. The bottom line is that most value investors live rather frugally and would rather invest their money than spend it. They understand that growth happens at the edge of comfort and discomfort. Value investors are willing to endure the discomfort of delaying short term gratification in exchange for long term gain. In summary, value investing is more than a method. It is a belief system, a methodology, a psychology, a delay of short term gratification, a way of life. Value investing is about mind, method and money. Value investors are wired a little differently, they think about wealth creation just like mountaineers think about achieving the highest summit: it is an all or nothing journey! |
Active Value Investing in South AfricaPlease have a look at my Value Investing Blog. Here I discuss approaches to value investing and do share valuations for the JSE. I also post regular and relevant market comment.
I have recently started writing for MoneyWeb and hope to be doing radio interviews soon. Please also have a look at my Fear and Greed Index that I post once a week. It is a compound index of the fear versus greed emotion dominating the Johannesburg Stock Exchange. |
I have committed myself to this journey for the rest of my life. I hope that my writing will inspire you as well to commit to creating sustainable wealth.
Be Extraordinary!
Myles Rennie
Be Extraordinary!
Myles Rennie