Markets

What We Value

What exactly is "value investing" and why don't more people do it?

By Whitney Tilson, Contributing Editor

John Heins, Contributing Editor

From Kiplinger's Personal Finance magazine, July 2008

A walk down any supermarket aisle makes it clear we live in a world of increasing product specialization. To break into a new market or grab more of an existing one, companies launch a dizzying array of new products in ever-more-specific categories. Want your soda with more caffeine or less? You've got it. More sugar? Less sugar? Six ounces, 10 ounces, 20 ounces? Whatever you like.

This trend has not been lost on marketers of investments. Specialized mutual funds and exchange-traded funds cover almost every imaginable combination of manager style, geographic reach, capitalization size and sector expertise. If you're looking for a mid-cap growth fund focused on the so-called BRIC countries (Brazil, Russia, India and China), you'll surely find it.

Dyed in the wool

We understand the marketing reality of specialization, but we'd argue that the most important factor in judging an investor's prospective gains or losses is the person's underlying philosophy. As you might guess from the name of this column, we're dyed-in-the-wool value investors, and we agree 100% with Berkshire Hathaway's vice-chairman, Charlie Munger, that "all sensible investing is value investing."

What does that mean? After all, value investors pursue a wide variety of strategies: Some invest primarily in small companies, while others like large ones. Some go mostly overseas while others stick to the U.S. Some run concentrated portfolios, and others don't. Some are activists; others aren't. But although specific strategies vary, the fundamental characteristics that unite value investors are many. We've come up with an even dozen:

1. We tend to buy what's out-of-favor rather than what's popular.

2. We focus on intrinsic company value -- what it's really worth -- and buy only when we're convinced we have a substantial margin of safety rather than try to guess where the herd will go next.

3. We understand and profit from reversion to the mean rather than project the immediate past indefinitely into the future.

4. We understand that beating the market requires a portfolio that looks quite different from the market, and we recognize that truly great investment ideas are rare. So we invest heavily in our handful of best ideas rather than hide behind the safety of closet indexing.

5. We focus on avoiding permanent losses and on absolute returns rather than on outperforming a benchmark and on relative returns.

6. We typically invest with a multiyear time horizon rather than focus on the month or quarter ahead.

7. We pride ourselves on conducting in-depth and proprietary analysis in search of what hedge-fund legend Michael Steinhardt calls "variant perceptions" rather than acting on tips or relying on Wall Street analysts.

8. We spend much of our time reading -- business publications, annual reports and the like -- rather than staring at the ticker or watching television shows about the market.

9. We spend time analyzing and understanding "micro" factors, such as a company's competitive advantages and growth prospects, instead of trying to predict the direction of interest rates, oil prices and the economy.

10. We cast a wide net, seeking mispriced securities across industries and across types and sizes of companies rather than accepting artificial style-box limitations on market capitalization and other criteria.

11. We make our own decisions and are willing to be held accountable for them rather than seek safety in whatever everyone else is buying or in decision-making by committee.

12. We admit our mistakes and seek to learn from them rather than take credit only for successes and attribute failures to bad luck.

If that all sounds perfectly sensible, you might wonder, as we sometimes do, why everyone isn't a value investor. A simple explanation is that you must be able to estimate the value of a business, which requires a great deal of skill and experience to do with reasonable accuracy. There are other explanations as well. James Montier, equity strategist at France's Société Générale, has studied the subject and finds the reasons are deeply rooted in human nature -- and, therefore, unlikely to ever change.

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