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Value Investing: From Graham to Buffett and Beyond
From the "guru to Wall Street's gurus" comes the fundamental techniques of value investing and their applications
Bruce Greenwald is one of the leading authorities on value investing. Some of the savviest people on Wall Street have taken his Columbia Business School executive education course on the subject. Now this dynamic and popular teacher, with some colleagues, reveals the fundamental principles of value investing, the one investment technique that has proven itself consistently over time. After covering general techniques of value investing, the book proceeds to illustrate their applications through profiles of Warren Buffett, Michael Price, Mario Gabellio, and other successful value investors. A number of case studies highlight the techniques in practice.
Bruce C. N. Greenwald (New York, NY) is the Robert Heilbrunn Professor of Finance and Asset Management at Columbia University. Judd Kahn, PhD (New York, NY), is a member of Morningside Value Investors. Paul D. Sonkin (New York, NY) is the investment manager of the Hummingbird Value Fund. Michael van Biema (New York, NY) is an Assistant Professor at the Graduate School of Business, Columbia University.
Bruce Greenwald is one of the leading authorities on value investing. Some of the savviest people on Wall Street have taken his Columbia Business School executive education course on the subject. Now this dynamic and popular teacher, with some colleagues, reveals the fundamental principles of value investing, the one investment technique that has proven itself consistently over time. After covering general techniques of value investing, the book proceeds to illustrate their applications through profiles of Warren Buffett, Michael Price, Mario Gabellio, and other successful value investors. A number of case studies highlight the techniques in practice.
Bruce C. N. Greenwald (New York, NY) is the Robert Heilbrunn Professor of Finance and Asset Management at Columbia University. Judd Kahn, PhD (New York, NY), is a member of Morningside Value Investors. Paul D. Sonkin (New York, NY) is the investment manager of the Hummingbird Value Fund. Michael van Biema (New York, NY) is an Assistant Professor at the Graduate School of Business, Columbia University.
311 pages, Paperback
First published May 31, 2001
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January 24, 2021
I really enjoyed the first edition of this book, which I read almost 20 years ago. The two approaches to valuation prescribed in that edition were refreshingly straightforward. The most conservative approach was the asset-based valuation. Estimate a company’s asset reproduction value and buy at a discount. The next-most conservative approach was the earnings power-based valuation. Calculate normalized earnings (assuming no growth) and divide by the cost of capital. Both approaches were to-the-point and practically-applicable.
I was therefore quite surprised when Bruce Greenwald recently stated in an interview that he thought the first edition of the book wasn’t very good, and that this second edition, 20 years later, was better. The second edition would apparently incorporate a “returns-based” framework for analyzing growth stocks -- going far beyond the two methods described above. Intrigued, I bought a copy.
Long story short -- I think this second edition -- in particular Chapter 8, the new chapter on valuing growth stocks -- completely loses the plot. In fact, I think that the “returns-based” model ruins the entire book. At the very least, it serves to remind the reader that the (five!) authors have limited real-world investing experience (on any real scale). What follows is a (very) long review. I’d usually refrain from writing a review at all, but given that this book is supposed to be one of the seminal texts in the field of value investing (and given that I am an avid value investor), I felt that its shortcomings should be highlighted.
Let me get straight to the point: no one who actually runs money for a living evaluates growth stocks in the manner prescribed in Chapter 8. The authors pitch their “returns-based” approach as a superior alternative to the DCF, because, as they note, the DCF is sensitive to assumptions and results in a much greater variance of outcomes. The authors contend that, as a result of these variances, calculating the intrinsic value of a rapidly growing company is “impossible”. I find this to be ridiculous. Any attempt at valuation will be subject to a significant degree of error. The idea is not total precision. The DCF is king because it is the literal definition of valuation: a company is worth the sum of its future free cash flows, discounted back to the present. Full stop. The earnings power value approach prescribed earlier in the book IS a DCF -- just one that assumes no growth! Moreover, the earnings power value approach suffers from huge variances depending on the discount rate chosen. Yet the authors are OK endorsing it. Just because a rapidly growing company will result in a wider range of DCF outcomes doesn’t mean that you throw the whole methodology away!
Sadly, the proposed replacement methodology is limited to the point of being useless. The authors’ recommended process for analyzing growth stocks is as follows: take a company’s current distributable earnings yield, and add to it your estimate of that company’s long-run organic growth rate. That’s it. The combination of these two things is your expected return. If this return is higher than your cost of capital, then invest in said growth stock! If it is lower, then don’t.
The authors then distinguish between “market-based” organic growth, and organic growth driven by “active investment”. I have no qualms with this distinction, and the “active investment” piece speaks to the importance of return on capital exceeding cost of capital.
But then there is a needlessly complex further digression highlighting the fact that the organic growth component of the total return equation above doesn’t actually equate to the “real” return that an investor should expect if a company’s market value is above its intrinsic value. There is also an appendix to Chapter 8 that will only serve to confuse readers. The second part of this appendix (or maybe the entire appendix) is written by someone who I'd bet has never managed real money.
But now I’m digressing. As I noted, the authors’ method of analyzing growth stocks with their new approach is extremely limited, for several reasons. First, their model cannot handle long-run organic growth rates much higher than 10%, for otherwise the target company would eventually grow to be the size of the entire economy. The authors point this out, but then do nothing about it. So the “returns-based” model does not work for ANY company that is growing quickly (say, 15-25-35% a year for the next 5-7 years). The model also does not work for companies that are losing money or have no retained earnings, or for companies that have dramatically varying year-to-year growth rates. I would say that the above three categories encompass perhaps 90% of all of the interesting growth stocks out there. A DCF approach, of course, works for all three.
The authors’ method instead works for only ONE type of growth stock opportunity: the slow-and-steady grower that is profitable. The stalwart-type company. But even for this type of company, the results of the model are nonsensical. Consider a simple example. Imagine a dominant, competitively-advantaged company that is 100% equity financed, that has no excess cash or debt, and that trades at a 20x P/E. Imagine that this company is able to reinvest all of its earnings each year and generate a 20% return on investment. Imagine that this company has a very long growth runway, and can keep reinvesting pretty much indefinitely. In other words, this is a company that grows both revenue and earnings at 20% annualized for many years. Imagine that your cost of capital is 10%.
Based on the authors’ methodology, this company’s distributable earnings yield is 0%, given the fact that all of its earnings are being reinvested. This 100% “active reinvestment”, at a 20% ROI versus our 10% cost of capital, implies a “value creation ratio” (authors’ term) of 2.0x. 2.0x multiplied by the 5% retained earnings yield results in an expected future growth “return” of 10%. So, to summarize the authors’ approach: a 0% distributable earnings yield + a 10% growth return equals your total expected return of 10%.
Given that our assumed cost of capital is also 10%, and given that we haven’t taken into account “fade rates” yet (another concept introduced by the authors with almost no real-world value), we should be indifferent as to whether or not we make this investment. After accounting for “fade”, the authors’ methodology would actually recommend avoiding this investment altogether!
Any seasoned practitioner will tell you that a dominant company trading at 20x earnings that can reinvest all of its earnings at 20% incremental returns on capital for a very long time... is very likely to be a good investment. If you plug the same figures above into a 10-year DCF and assume a terminal growth rate of 5%, the DCF will tell you that this particular company is worth nearly 40x earnings, rather than 20x. Yet with the authors’ model, the correct answer is to pass on the investment! No sane investor would pass on this!
The authors’ model would have dismissed Heico a decade ago as a pass. The model would have dismissed Copart a decade ago. The model would have dismissed Constellation Software a decade ago. The model would have dismissed Old Dominion Freight Lines a decade ago. Go and take a look at what all of those stocks have done since 2010. The authors’ model would have dismissed any number of similarly great investments across the globe.
Even the authors’ specifically-chosen examples in the book illustrate the uselessness of their “returns-based” model! For example, the authors apply their model to Intel, and the model ends up suggesting that Intel stock offered a better prospective return in March of 1999 (at 10.6% annualized and 5.5% “adjusted”) than in March of 2003 (at 8.2% annualized and 3.7% “adjusted”). Zooming out for a moment, in March of 1999, the internet bubble was in full swing. Intel was trading at a near-peak valuation of almost 40x earnings. In March of 2003, the internet bubble had popped and Intel was trading at a much more reasonable mid-teens normalized earnings multiple. Yet the authors (of a book on value investing, no less!) suggests that Intel would have offered higher prospective returns in 1999 than in 2003.
What actually happened? In the 10 years from March of 1999 onward, Intel returned -7.3% a year. In the 10 years from March of 2003 onward, Intel returned +5.2% a year. Intel was a much better buy at the bottom in 2003 than at the top in 1999, though the “returns-based” model indicated the opposite.
One small addendum on Intel -- even with their own example, the authors could barely make their returns-based model work. From 1991 to 1998, Intel grew revenue at a 28% annualized rate. But assuming such a high organic growth rate would break the model. So the authors instead arbitrarily assume that Intel’s organic growth rate from 1999 onward should be 8.5%, which is based on a 1999 GDP forecast of 5-6% and an assumed 3% “natural” organic growth rate. This 8.5% growth rate literally had no relationship with Intel’s actual business performance at the time. It was just shoe-horned in, because the authors’ model cannot handle anything but single-digit longer-term growth rates!
I don't know how to put this any more clearly: the authors' "expected returns" model for evaluating growth stocks is useless for 90% of growth stocks, is useless even for the growth stocks that fit within the model's parameters, and leads to both nonsensical assumptions and nonsensical results in the author's own examples.
As a final aside, I was also disappointed by the sheer number of errors throughout the book. There are a litany of basic spelling and typographical errors. There are errors in the mathematical formulas in the appendices. There are errors related to the calendar dates quoted in the Intel example. And then there are other inexplicable inconsistencies that further evidence the fact that the book has five authors working separately. For example, in the WD-40 example, the author uses a “real”, rather than “nominal”, organic growth rate estimate. In no other section of the book are “real” growth rates used. Instead, the other examples always use nominal rates inclusive of inflation. No explanation is given for this inconsistency.
Ultimately, I think the first edition of this book was quite good. I think this edition is significantly worse.
I was therefore quite surprised when Bruce Greenwald recently stated in an interview that he thought the first edition of the book wasn’t very good, and that this second edition, 20 years later, was better. The second edition would apparently incorporate a “returns-based” framework for analyzing growth stocks -- going far beyond the two methods described above. Intrigued, I bought a copy.
Long story short -- I think this second edition -- in particular Chapter 8, the new chapter on valuing growth stocks -- completely loses the plot. In fact, I think that the “returns-based” model ruins the entire book. At the very least, it serves to remind the reader that the (five!) authors have limited real-world investing experience (on any real scale). What follows is a (very) long review. I’d usually refrain from writing a review at all, but given that this book is supposed to be one of the seminal texts in the field of value investing (and given that I am an avid value investor), I felt that its shortcomings should be highlighted.
Let me get straight to the point: no one who actually runs money for a living evaluates growth stocks in the manner prescribed in Chapter 8. The authors pitch their “returns-based” approach as a superior alternative to the DCF, because, as they note, the DCF is sensitive to assumptions and results in a much greater variance of outcomes. The authors contend that, as a result of these variances, calculating the intrinsic value of a rapidly growing company is “impossible”. I find this to be ridiculous. Any attempt at valuation will be subject to a significant degree of error. The idea is not total precision. The DCF is king because it is the literal definition of valuation: a company is worth the sum of its future free cash flows, discounted back to the present. Full stop. The earnings power value approach prescribed earlier in the book IS a DCF -- just one that assumes no growth! Moreover, the earnings power value approach suffers from huge variances depending on the discount rate chosen. Yet the authors are OK endorsing it. Just because a rapidly growing company will result in a wider range of DCF outcomes doesn’t mean that you throw the whole methodology away!
Sadly, the proposed replacement methodology is limited to the point of being useless. The authors’ recommended process for analyzing growth stocks is as follows: take a company’s current distributable earnings yield, and add to it your estimate of that company’s long-run organic growth rate. That’s it. The combination of these two things is your expected return. If this return is higher than your cost of capital, then invest in said growth stock! If it is lower, then don’t.
The authors then distinguish between “market-based” organic growth, and organic growth driven by “active investment”. I have no qualms with this distinction, and the “active investment” piece speaks to the importance of return on capital exceeding cost of capital.
But then there is a needlessly complex further digression highlighting the fact that the organic growth component of the total return equation above doesn’t actually equate to the “real” return that an investor should expect if a company’s market value is above its intrinsic value. There is also an appendix to Chapter 8 that will only serve to confuse readers. The second part of this appendix (or maybe the entire appendix) is written by someone who I'd bet has never managed real money.
But now I’m digressing. As I noted, the authors’ method of analyzing growth stocks with their new approach is extremely limited, for several reasons. First, their model cannot handle long-run organic growth rates much higher than 10%, for otherwise the target company would eventually grow to be the size of the entire economy. The authors point this out, but then do nothing about it. So the “returns-based” model does not work for ANY company that is growing quickly (say, 15-25-35% a year for the next 5-7 years). The model also does not work for companies that are losing money or have no retained earnings, or for companies that have dramatically varying year-to-year growth rates. I would say that the above three categories encompass perhaps 90% of all of the interesting growth stocks out there. A DCF approach, of course, works for all three.
The authors’ method instead works for only ONE type of growth stock opportunity: the slow-and-steady grower that is profitable. The stalwart-type company. But even for this type of company, the results of the model are nonsensical. Consider a simple example. Imagine a dominant, competitively-advantaged company that is 100% equity financed, that has no excess cash or debt, and that trades at a 20x P/E. Imagine that this company is able to reinvest all of its earnings each year and generate a 20% return on investment. Imagine that this company has a very long growth runway, and can keep reinvesting pretty much indefinitely. In other words, this is a company that grows both revenue and earnings at 20% annualized for many years. Imagine that your cost of capital is 10%.
Based on the authors’ methodology, this company’s distributable earnings yield is 0%, given the fact that all of its earnings are being reinvested. This 100% “active reinvestment”, at a 20% ROI versus our 10% cost of capital, implies a “value creation ratio” (authors’ term) of 2.0x. 2.0x multiplied by the 5% retained earnings yield results in an expected future growth “return” of 10%. So, to summarize the authors’ approach: a 0% distributable earnings yield + a 10% growth return equals your total expected return of 10%.
Given that our assumed cost of capital is also 10%, and given that we haven’t taken into account “fade rates” yet (another concept introduced by the authors with almost no real-world value), we should be indifferent as to whether or not we make this investment. After accounting for “fade”, the authors’ methodology would actually recommend avoiding this investment altogether!
Any seasoned practitioner will tell you that a dominant company trading at 20x earnings that can reinvest all of its earnings at 20% incremental returns on capital for a very long time... is very likely to be a good investment. If you plug the same figures above into a 10-year DCF and assume a terminal growth rate of 5%, the DCF will tell you that this particular company is worth nearly 40x earnings, rather than 20x. Yet with the authors’ model, the correct answer is to pass on the investment! No sane investor would pass on this!
The authors’ model would have dismissed Heico a decade ago as a pass. The model would have dismissed Copart a decade ago. The model would have dismissed Constellation Software a decade ago. The model would have dismissed Old Dominion Freight Lines a decade ago. Go and take a look at what all of those stocks have done since 2010. The authors’ model would have dismissed any number of similarly great investments across the globe.
Even the authors’ specifically-chosen examples in the book illustrate the uselessness of their “returns-based” model! For example, the authors apply their model to Intel, and the model ends up suggesting that Intel stock offered a better prospective return in March of 1999 (at 10.6% annualized and 5.5% “adjusted”) than in March of 2003 (at 8.2% annualized and 3.7% “adjusted”). Zooming out for a moment, in March of 1999, the internet bubble was in full swing. Intel was trading at a near-peak valuation of almost 40x earnings. In March of 2003, the internet bubble had popped and Intel was trading at a much more reasonable mid-teens normalized earnings multiple. Yet the authors (of a book on value investing, no less!) suggests that Intel would have offered higher prospective returns in 1999 than in 2003.
What actually happened? In the 10 years from March of 1999 onward, Intel returned -7.3% a year. In the 10 years from March of 2003 onward, Intel returned +5.2% a year. Intel was a much better buy at the bottom in 2003 than at the top in 1999, though the “returns-based” model indicated the opposite.
One small addendum on Intel -- even with their own example, the authors could barely make their returns-based model work. From 1991 to 1998, Intel grew revenue at a 28% annualized rate. But assuming such a high organic growth rate would break the model. So the authors instead arbitrarily assume that Intel’s organic growth rate from 1999 onward should be 8.5%, which is based on a 1999 GDP forecast of 5-6% and an assumed 3% “natural” organic growth rate. This 8.5% growth rate literally had no relationship with Intel’s actual business performance at the time. It was just shoe-horned in, because the authors’ model cannot handle anything but single-digit longer-term growth rates!
I don't know how to put this any more clearly: the authors' "expected returns" model for evaluating growth stocks is useless for 90% of growth stocks, is useless even for the growth stocks that fit within the model's parameters, and leads to both nonsensical assumptions and nonsensical results in the author's own examples.
As a final aside, I was also disappointed by the sheer number of errors throughout the book. There are a litany of basic spelling and typographical errors. There are errors in the mathematical formulas in the appendices. There are errors related to the calendar dates quoted in the Intel example. And then there are other inexplicable inconsistencies that further evidence the fact that the book has five authors working separately. For example, in the WD-40 example, the author uses a “real”, rather than “nominal”, organic growth rate estimate. In no other section of the book are “real” growth rates used. Instead, the other examples always use nominal rates inclusive of inflation. No explanation is given for this inconsistency.
Ultimately, I think the first edition of this book was quite good. I think this edition is significantly worse.
March 23, 2013
We hear a lot of people talking about value investing (and quite as many talking about other investing ways). Many of the speakers try to use different and creative ways to “fit” their own theories and strategies into the value investing box, many misrepresent the basic concepts of value investing reasoning that new times require new tools
Value investing is not a new concept. It was defined and taught by Professor Benjamin Graham more than eighty years ago. Professor Graham researched, defined, taught and wrote extensively about methods of valuing companies, deciphering financial statements and finding the companies intrinsic value. However it is 2013 now and many say all this is irrelevant.
And then came, Professor Greenwald.
In this insightful book Professor Greenwald not only explains the basic concepts and definitions behind Professor Grahams teaching but also takes the reader many steps further. Professor Greenwald explores the way value investing evolved over the years and how the basic concepts were used and modified by Graham disciples to support the present environment without letting past concepts be forgotten.
Professor Greenwald very nicely weaves the teaching of Professor Graham and his #1 student, Mr. Warren Buffett, into an elaborate but yet simple to understand book about understanding and applying value investing techniques. He is doing so not by dismissing past lessons but by embracing the past and adapting it to current times.
As an added bonus, I found Professor Greenwald several real life examples of valuing companies by using the discussed valuation techniques very useful. I also would like to commend the author for profiling eight successful value investors and highlighting their different methods of applying valuation concepts when researching for suitable investments.
Read this book, I know you will appreciate decade’s long investment truths, as well as present time applications in your search for finding companies intrinsic value.
If you are interested in the media industry, I would recommend Professor Greenwald book “The Curse of the Mogul” which deciphers the media industry (as a potential investment field). I believe reading it while applying the lessons taught by Professor Greenwald in “Value Investing” will be very insightful.
Amir Avitzur
Value investing is not a new concept. It was defined and taught by Professor Benjamin Graham more than eighty years ago. Professor Graham researched, defined, taught and wrote extensively about methods of valuing companies, deciphering financial statements and finding the companies intrinsic value. However it is 2013 now and many say all this is irrelevant.
And then came, Professor Greenwald.
In this insightful book Professor Greenwald not only explains the basic concepts and definitions behind Professor Grahams teaching but also takes the reader many steps further. Professor Greenwald explores the way value investing evolved over the years and how the basic concepts were used and modified by Graham disciples to support the present environment without letting past concepts be forgotten.
Professor Greenwald very nicely weaves the teaching of Professor Graham and his #1 student, Mr. Warren Buffett, into an elaborate but yet simple to understand book about understanding and applying value investing techniques. He is doing so not by dismissing past lessons but by embracing the past and adapting it to current times.
As an added bonus, I found Professor Greenwald several real life examples of valuing companies by using the discussed valuation techniques very useful. I also would like to commend the author for profiling eight successful value investors and highlighting their different methods of applying valuation concepts when researching for suitable investments.
Read this book, I know you will appreciate decade’s long investment truths, as well as present time applications in your search for finding companies intrinsic value.
If you are interested in the media industry, I would recommend Professor Greenwald book “The Curse of the Mogul” which deciphers the media industry (as a potential investment field). I believe reading it while applying the lessons taught by Professor Greenwald in “Value Investing” will be very insightful.
Amir Avitzur
June 2, 2015
This is quite a decent primer on Value Investing - the first half of the book is dedicated to principles of valuation which is such a large topic I'm not sure that a cursory overview adds much to the book. If you're just starting out I imagine it quite useful but there are better books on risk management, portfolio construction and valuation itself (by Nick Radge and Aswath Damadoran for example). The second half is a fantastic journey through the careers of some value investing greats and give you a variety of perspectives on valuation. In the end I came away from this book thinking that provided one sticks with a consistent valuation framework (DCF or otherwise) and buys good businesses at reasonable prices, preferably with a large margin of safety then it won't matter too much what you're buying; if in 20-30 years it is still a wonderful business it will be likely worth substantially more. Of course, that's easier said than done otherwise I'd be writing a cheque for an Aston Martin rather than a review for a book on value investing.
March 25, 2017
I read the first half of this book, put it down for a few months, and then picked it up again. I probably shouldn't have done that.
First half: great.
Second half: not great.
First half basically reads like a textbook. A good discussion of various methodologies and value investing strategies. Second half is very little value-add. Basically a few case studies / biographies / investor letters from some of the luminaries in the value investment world. They felt stale. I wonder if any of them are still actively investing and how they are able to keep up.
First half: great.
Second half: not great.
First half basically reads like a textbook. A good discussion of various methodologies and value investing strategies. Second half is very little value-add. Basically a few case studies / biographies / investor letters from some of the luminaries in the value investment world. They felt stale. I wonder if any of them are still actively investing and how they are able to keep up.
December 27, 2016
Chapters 4 to 7 will change the way you value companies forever! a must read
March 29, 2018
A good read - The foundation of the book is laid based on the concepts introduced by Benjamin Graham - who is commonly credited with establishing Security analysis as a firm discipline. The author tried to build on the works of Benjamin Graham and on that of his successors and incorporated the advances in value investing that have appeared over the last 40 years.
The book is divided into three parts. Part one is the introduction, part two is the crux of this book. Part 3 gives us bird’s eye view of investment strategies made by renowned value investors including Warren Buffett.
This book is an interesting read because it gives fresh perspective on how to analyse a company in a different manner compared to the traditional DCF approach. 4 stars.
The book is divided into three parts. Part one is the introduction, part two is the crux of this book. Part 3 gives us bird’s eye view of investment strategies made by renowned value investors including Warren Buffett.
This book is an interesting read because it gives fresh perspective on how to analyse a company in a different manner compared to the traditional DCF approach. 4 stars.
February 1, 2020
Provides a good basic overview, useful for those new to value investing. Enjoyed the investor profiles in the second part of the book, especially of Glenn Greenberg of Chieftain Capital. Deep research on a small number of stocks, all four team members have to agree before a stock enters the portfolio. Will look to do more reading on him.
December 7, 2024
Value Investing
In search of a universe
- specialization of industry helps to be on the right side of the trade
- Statistical returns show small cap, low book-to-market, cash flow-to-price (FCF yield), slow rate of sales growth, and underperformance over the last three years.
- Return on equity or ROIC, growth in eps, and increase in asset base and high-profit margin, the higher, the worse they perform to their peer set. It could be seen as a return to the medium or cyclical pressures
- Behavioral reasons for value anomaly humans want lotto tickets (high-flying stocks to get rich off), loss aversion (ugly stocks feel like you can lose your shirt), certainty tendency (humans tend to think in absolutes when it’s better to think probabilities)
Valuation in principle, valuation in practice
- Two methods, multiples and DCF
- Both have downfalls and issues. It's all an art and science—DCF, too many assumptions, garbage in, garbage out. Multiples vary based on market conditions. They could be overinflated or underinflated based on sentiment.
- Could you look at the balance sheet to understand where the business is today? Graham, back in the day, was looking for net-net's current assets minus all liabilities. These are rare now, given the highly recognized need to adjust the balance sheet for the actual value of assets and claims on the business. When evaluating the balance sheet, you should try to determine the cost of reproducing the assets and how much they are worth on the books
- Earning power value by taking earnings and normalizing them for one-time charges and consistency of capex to d&a and dividing by the cost of capital. This gives you a value for the stream of cash flows in perpetuity. You should add in any value on the balance sheet that can be disposed of without affecting the ongoing core business and subtract liabilities as well that hurt the EPV
- Growth is the hardest to value given its the future but to think appropriately about whether growth actually adds value to the business by analyzing the industry dynamics
- We would then compare the value between EPV and asset value if assets bigger than EPV means industry is unviable given the cost of capital you could reproduce the assets cheaper and get a better yield on current cost. If AV annd EPV come in 25% of each other typically means a competitive industry no inherent moat given cost of capital produces the same asset value as on the book.
- A potential indication of a moat is assets < EPV. This indicates that competitors could unlikely recreate your business with the same assets as you are earning an excess on the asset values cost of capital.
- Competitive advantages come from proprietary tech (process), priviledged access to customers (high switching cost) and economies of scale (low cost producer)
Valuing the assets from book value to replacement cost
- liquidation value - have to adjust the balance sheet for expected realized value of existing assets and claims - need liquidation to happen in a timely manner and can run npv on a short term to find value of remaining cash flows. The danger with this is of management tries to extend the useful life of the business is agent principal hazarard
- Going concern value for the balance sheet need to think about what would it cost an upstart to build this business so value the balance on a replacement cost basis. The current accounts are pretty straightforward but the long term assets require industry expertise - all about cost to reproduce many ways to get answers here also need to think about the industry and intangibles not on the balance sheet (r&d times time to develop or r&d times product life), value of customer relationships, value of labor force - value of m&a what would a private buyer pay
- Really need to understand each line of the balance sheet and what it represents
Earning power value
- this method has an assumption of perpetual growth so its a little less rooted in reality but is better than a bunch of npv calculations with tons of assumptions
- First things first defining earning power is the sustainable distributable earnings or the average earnings that a Company would produce if the underlying operation continues without change. Average is to account for business cycle as well as other fluctuations.
- Average cost of capital you know the assumptions here
- Earning power divided by cost of capital equals earning power value equivalent to the enterprise value you can then compare asset value to epv by adjusting from EV to equity value or the other way to get enterprise value going equity value of asset value to enterprise value.
Magna International case study
- at the height of the GFC Magna international (auto part maker) was trading at 2.2b equity value given the general turmoil of auto companies and shareholders frustration with management investments in horse tracks etc. Also some questionable investments in JV with Russian oligarch that had to sell out when alumninum prices dropped
- Stock price dropping 80% made it worth while to dig in a little trading at 30% of book value
- PE was 31.5x but that was given taxes and depressed earnings need to see sustainable earnings
- Filters
- 1 is there a chance of bankruptcy (downside management): not likely given cash greater than debt and operating cash flow minus investmwnt positive
- 2 long run future of the auto part industry given the challenges in the industry could of felt like chicken little but rationally speaking people were still going to be driving cars given nothing in transportation technology had changed. The north American and European industry were also onshoring given less need for workers due to automation. Given unionalization and high wage levels at the big auto producer auto pat manufactures like magma were still going to be used
- Competitive landscape highlights a lack of competitive advantage meaning it all comes down to exection
- First things first is calculation reproduction value
- - land and buildings from talking to assessors highlight asset prices in the place they are based have increased 25%
- - Constriction in progress could be seen as fair value
- - Machinery needs to take into account depreciation (no growth assume half life, growth slightly less than half way, and decline more than half way) so for magma assuming halfway then how much to buy new machinery (taking account inflation or deflation)
- If reproduction greater than original cost we add to book value of equity
- Intangibles (remove goodwill completely and recreate with estimates for intangibles)
- - customer base value (sales divided by fees in building a sales book)
- - Trained work force value (number of skilled work force by the recruiting cost per employee) some recruitment firms charge 1/3 per higher as an estimate
- - product portfolio could be seen as how much to reporduce the portfolio
- One way to see if this intangible value makes sense is to look at the value to sg&a
- Epv nopat and divide by depreciation as economic capital cost vs accounting capital cost
- A way to think of this is to look at the average capex and d&a for a business cycle period and what sales grew by in that period to a ratio of fixed assets. Use that to multiply revenue growth to capital investment which gives you a sense of growth capex supremacy from total capex gives you maintaince capex
- Accounting d&a - Maintaince capex = gap take into account growth by dividing by scale then add to nopat for sustainable earning power
- Compare asset value to epv think through the risk of being wrong on key assumptions
Growth
- It is only valuable if it actually creates value and you don’t over pay for it
- Growth always requires investment very rare to get growth with no investment need to consider the additional investment and the cost of that investment to the return
- How can you tell when growth is value destructive, neuatral or value creative?
- 1 expansion into markets or product lines where it has no sustainable competitive advantages ie no benefits from barriers to entry - all excess returns will be eaten away by competition potentially destroy value given oversupply driving returns lower
- 2 firms seeking to enter a market with incumbents are likely to do worse with no competitive advantage operation will be limited in scale and earn a return below cost of capital
- 3 only place to win with growth is when producing a return above the cost of capital and this happens only when actual competitive advantages can work their magic
- This can be seen manifested in the cases of AV>EPV no competitive advantage and fighting disadvantaged. AV=EPV likely level playing field only returning cost of capital no value creation. AV- Competitive conditions must be examined for understanding if growth has value
- 1. Organic growth (no investment growth ex no customer acquisition spend better k factor or local economy growth benefiting walmart while sustaining their competitive advantage)
- 2 other favorable economic developments (new tech ex reducing cost but if everyone has access no benefit think of the textile factories)
- 3 growth optionality value (entering new markets but copy cats will follow if no sustainable competitive advantage)
- 4 market shrinking consideration (sometimes economy of scales can work against you if the product or service will not be used in the future look at the newspapers)
- 5 growth in core markets vs new markets
Good businesses
- clarity rarely begins with complex numerical calculations
- Sustainable competitive advantages are observable through high market share and high roic and these are grounded in economies of scale and or network effects protected by customer captivity, regulatory hurdles and proprietary technology
- - things to observe market dominance over time failed entry demonstrable economy of scales through comparison with competitors
- The dynamics of competitors also creates a potential sustainable favorable economic environment for the duopoly, oligarchy etc
- Competitive advantages are the exception rather than the rule (government made regulations, cost and revenue advantages ex production techniques and know how downward sloping learning curve can this accessed by competitors, customer captivity high switching cost )
- Some notes low cost labor and capital is rare and unlikely to be sustainable as labor and capital will move to where ever most efficiently used and push up cost of labors as those in the market compete
Valuing a franchise business
- Given the challenges growth poses for using asset based and epv being perpetual constant state as a valuation method we should look at returns in assessing franchise businesses
- Evaluating returns based on cash, organic growth and active growth
- Cash returns is taking the company’s sustainable earnings by market value for a sustainable earning yield then multiplying by the percent expected to be paid to shareholders through stock buybacks and dividends that gets you the cash return on current earning power the differential should be accounted by the organic and active growth of the business
- Organic growth will be enjoyed in markets where the player has a sustainable competitive advantage (pricing power) could also come from rising tide of the product or service offered (population growth, rising household incomes). Second is cost reduction improving efficiency this will raise profit margin in markets with enough barriers to entry this can add to organic growth value.
- A few ways to estimate organic growth: 1. Historical growth rate but need to keep in mind how this has been trending to the historical. 2. GDP growth with adjustments for where the product is sold (top down) 3 bottom up look at the foot traffic and capacity for growth
- Need to factor in the cost advantage as well to this organic growth get down to the unit economics for every dollar of growth how much working capital needs to be invested as well.
- Active investment growth needs to be measured by what management is investing the remaining retained earnings too. This is all about capital allocation what does management do with the retained earnings.
- You add these three factors up to get the returns you need to compare that return to alternatives to know what the best opportunity is for equities can look at cost of capital (WACC), returns relative to total market so spy dividend return + growth and 1/PE of spy + inflation
- Fade risk needs to be taken into account but estimimating this is so hard but basically using the rule of 72 divide by the number of years in the future where the franchise survival probability declines to 50%
- Dividend discount model is very similar to what we are talking about in terms of cash returns + growth but our calc accounts for sharebuybacks which ddm does not another factor is single share analysis doesn't take into account the overall enterprise
- Shortfalls of returns based analysis
- 1. Expectation of a constant future and fade risk being higher or lower
- This return calculation has a lot of short falls to consider plus math that is qualitatively valuable but quantitavily imperfect.
WD-40 Case study
- relatively stable business but saturated unlikely to grow much given low frequency of puchase but at the time in 1998 was trading at 18x in a market of of 22-23x but their historical multiple was 17-18 as well.
- First step assess the franchise
- - customer captivity through customer loyalty and abscense of technology change, low purchase price of product made search cost high no point in trying substitutes
- - This leads to economy of scale as any one who wants to enter their market would squeeze retailer margins and wd variable cost would outweigh them
- Valueing the business in 1998 take sustainable earning power and dividend by cost of capital
- This led to the equity being over valued but doesn’t take into account the franchise value. In order to do this we examine it based on the returns so cash returns for the business where 5% given 86% payout ratio on 5.7% sustainable earnings to market value
- Organic growth we take into account where the growth will come from and how much working capital investment will be necessary to support the growth (AR/inventory to sales and Ap/accrued liabilities to sales) see if the sustainable earnings can support this working capital need to sales to distributions. That leaves the remaining distributable amount for reinvestment
- Evaluate managements past m&a by assessing the return on capital invested by looking at EPV to their investment
Research strategy
- most important part in researcch is investigating the key assumptions that underlie your valuation
- Indirect information: who owns the shares? Understand their track record in the industry, what are insiders doing buying is more an indication than selling given their can be many reasons they are selling. Is management issuing equity could be a negative sign for future returns depending on the use of equity. A network of experts to understand differing views and lastly what is consensus looked at impassionatly creates opportunity to understand counter and for arguments stay rational.
- Direct information need to uncover the extent, durability and consequences of specific competitive advantage and how it relates to its industry
- management, activism, and catalyst:
- A true assessment of management requires 1. operational efficiency in controlling cost in marketing and product development 2. capital allocation decisions around growth focus on profitable growth not just growth for growth sake. 3. financial structure and distribution to shareholders 4. Human resource management (talent management)
- Most important is operational efficiency as this produces a moat of being the low cost winner
- Growth should only be done if it produce value above their cost this only happens from sustainable competitive advantage such as customer captivatity through distribution or software and expanding to adjanent markets through core advantages (customer captivity and economies of scale)
- critical issues in research:
- 1. 80/20 get to the critical prospect like everything there is diminishing returns in research but you got to balance it because you have to turn every stone to find that key insight
- 2. Focus on long term trends not predicting the timing, duration and magnitude of changes that’s harder than identifying stability
Risk management and building portfolio
- often times risk is decentralized in portfolios leading to an aggregate portfolio that follows the market and has frictional cost
- Wealth owners must centralize risk management and capital allocation decisions
- Variance as a measure of risk is broken because the returns are asymmetrical, investments are capped at a 100% downside but unlimited upside
- That's why Graham and Dodd focused on the downside risk of permanent impairment of capital
- Arises from 3 sources 1. overpaying for a security, 2. excessive leverage (leading to bankruptcy or loss of competitive positioning due to diversion), 3. Unanticipated adverse developments affecting financial position of issuing company (company level - failure of new product, expansion fails, competitor makes inroads on their business, wrong priorities by management)(industry level - new tech that undermines current economic position or value of its assets, regulator changes that whittle down profitability, adverse impact of globalization, irrational competition)
- Inflation that is stable should benefit real assets as they can charge more for rents etc and make it worse for fixed income investments
- Deflation should benefit fixed income
- Franchise businesses (ex coca cola, fico etc) should do well in both environments given protection from intensified competition in deflation and pricing power in inflation
- Three types of insurance for the portfolio: options, selective short sales, cash - cash is typically the most selected
Some thoughts:
- businesses protected from relentless competition (usually duopoly with successful coexistence or local monopolies without threat of government intervention)
- Companies taking market share in a profitable way (high roic)
- Shareholder focused management - efficient operations, value enhancing capital allocation and distribution of excess funds as dividends or share buybacks
-
In search of a universe
- specialization of industry helps to be on the right side of the trade
- Statistical returns show small cap, low book-to-market, cash flow-to-price (FCF yield), slow rate of sales growth, and underperformance over the last three years.
- Return on equity or ROIC, growth in eps, and increase in asset base and high-profit margin, the higher, the worse they perform to their peer set. It could be seen as a return to the medium or cyclical pressures
- Behavioral reasons for value anomaly humans want lotto tickets (high-flying stocks to get rich off), loss aversion (ugly stocks feel like you can lose your shirt), certainty tendency (humans tend to think in absolutes when it’s better to think probabilities)
Valuation in principle, valuation in practice
- Two methods, multiples and DCF
- Both have downfalls and issues. It's all an art and science—DCF, too many assumptions, garbage in, garbage out. Multiples vary based on market conditions. They could be overinflated or underinflated based on sentiment.
- Could you look at the balance sheet to understand where the business is today? Graham, back in the day, was looking for net-net's current assets minus all liabilities. These are rare now, given the highly recognized need to adjust the balance sheet for the actual value of assets and claims on the business. When evaluating the balance sheet, you should try to determine the cost of reproducing the assets and how much they are worth on the books
- Earning power value by taking earnings and normalizing them for one-time charges and consistency of capex to d&a and dividing by the cost of capital. This gives you a value for the stream of cash flows in perpetuity. You should add in any value on the balance sheet that can be disposed of without affecting the ongoing core business and subtract liabilities as well that hurt the EPV
- Growth is the hardest to value given its the future but to think appropriately about whether growth actually adds value to the business by analyzing the industry dynamics
- We would then compare the value between EPV and asset value if assets bigger than EPV means industry is unviable given the cost of capital you could reproduce the assets cheaper and get a better yield on current cost. If AV annd EPV come in 25% of each other typically means a competitive industry no inherent moat given cost of capital produces the same asset value as on the book.
- A potential indication of a moat is assets < EPV. This indicates that competitors could unlikely recreate your business with the same assets as you are earning an excess on the asset values cost of capital.
- Competitive advantages come from proprietary tech (process), priviledged access to customers (high switching cost) and economies of scale (low cost producer)
Valuing the assets from book value to replacement cost
- liquidation value - have to adjust the balance sheet for expected realized value of existing assets and claims - need liquidation to happen in a timely manner and can run npv on a short term to find value of remaining cash flows. The danger with this is of management tries to extend the useful life of the business is agent principal hazarard
- Going concern value for the balance sheet need to think about what would it cost an upstart to build this business so value the balance on a replacement cost basis. The current accounts are pretty straightforward but the long term assets require industry expertise - all about cost to reproduce many ways to get answers here also need to think about the industry and intangibles not on the balance sheet (r&d times time to develop or r&d times product life), value of customer relationships, value of labor force - value of m&a what would a private buyer pay
- Really need to understand each line of the balance sheet and what it represents
Earning power value
- this method has an assumption of perpetual growth so its a little less rooted in reality but is better than a bunch of npv calculations with tons of assumptions
- First things first defining earning power is the sustainable distributable earnings or the average earnings that a Company would produce if the underlying operation continues without change. Average is to account for business cycle as well as other fluctuations.
- Average cost of capital you know the assumptions here
- Earning power divided by cost of capital equals earning power value equivalent to the enterprise value you can then compare asset value to epv by adjusting from EV to equity value or the other way to get enterprise value going equity value of asset value to enterprise value.
Magna International case study
- at the height of the GFC Magna international (auto part maker) was trading at 2.2b equity value given the general turmoil of auto companies and shareholders frustration with management investments in horse tracks etc. Also some questionable investments in JV with Russian oligarch that had to sell out when alumninum prices dropped
- Stock price dropping 80% made it worth while to dig in a little trading at 30% of book value
- PE was 31.5x but that was given taxes and depressed earnings need to see sustainable earnings
- Filters
- 1 is there a chance of bankruptcy (downside management): not likely given cash greater than debt and operating cash flow minus investmwnt positive
- 2 long run future of the auto part industry given the challenges in the industry could of felt like chicken little but rationally speaking people were still going to be driving cars given nothing in transportation technology had changed. The north American and European industry were also onshoring given less need for workers due to automation. Given unionalization and high wage levels at the big auto producer auto pat manufactures like magma were still going to be used
- Competitive landscape highlights a lack of competitive advantage meaning it all comes down to exection
- First things first is calculation reproduction value
- - land and buildings from talking to assessors highlight asset prices in the place they are based have increased 25%
- - Constriction in progress could be seen as fair value
- - Machinery needs to take into account depreciation (no growth assume half life, growth slightly less than half way, and decline more than half way) so for magma assuming halfway then how much to buy new machinery (taking account inflation or deflation)
- If reproduction greater than original cost we add to book value of equity
- Intangibles (remove goodwill completely and recreate with estimates for intangibles)
- - customer base value (sales divided by fees in building a sales book)
- - Trained work force value (number of skilled work force by the recruiting cost per employee) some recruitment firms charge 1/3 per higher as an estimate
- - product portfolio could be seen as how much to reporduce the portfolio
- One way to see if this intangible value makes sense is to look at the value to sg&a
- Epv nopat and divide by depreciation as economic capital cost vs accounting capital cost
- A way to think of this is to look at the average capex and d&a for a business cycle period and what sales grew by in that period to a ratio of fixed assets. Use that to multiply revenue growth to capital investment which gives you a sense of growth capex supremacy from total capex gives you maintaince capex
- Accounting d&a - Maintaince capex = gap take into account growth by dividing by scale then add to nopat for sustainable earning power
- Compare asset value to epv think through the risk of being wrong on key assumptions
Growth
- It is only valuable if it actually creates value and you don’t over pay for it
- Growth always requires investment very rare to get growth with no investment need to consider the additional investment and the cost of that investment to the return
- How can you tell when growth is value destructive, neuatral or value creative?
- 1 expansion into markets or product lines where it has no sustainable competitive advantages ie no benefits from barriers to entry - all excess returns will be eaten away by competition potentially destroy value given oversupply driving returns lower
- 2 firms seeking to enter a market with incumbents are likely to do worse with no competitive advantage operation will be limited in scale and earn a return below cost of capital
- 3 only place to win with growth is when producing a return above the cost of capital and this happens only when actual competitive advantages can work their magic
- This can be seen manifested in the cases of AV>EPV no competitive advantage and fighting disadvantaged. AV=EPV likely level playing field only returning cost of capital no value creation. AV- Competitive conditions must be examined for understanding if growth has value
- 1. Organic growth (no investment growth ex no customer acquisition spend better k factor or local economy growth benefiting walmart while sustaining their competitive advantage)
- 2 other favorable economic developments (new tech ex reducing cost but if everyone has access no benefit think of the textile factories)
- 3 growth optionality value (entering new markets but copy cats will follow if no sustainable competitive advantage)
- 4 market shrinking consideration (sometimes economy of scales can work against you if the product or service will not be used in the future look at the newspapers)
- 5 growth in core markets vs new markets
Good businesses
- clarity rarely begins with complex numerical calculations
- Sustainable competitive advantages are observable through high market share and high roic and these are grounded in economies of scale and or network effects protected by customer captivity, regulatory hurdles and proprietary technology
- - things to observe market dominance over time failed entry demonstrable economy of scales through comparison with competitors
- The dynamics of competitors also creates a potential sustainable favorable economic environment for the duopoly, oligarchy etc
- Competitive advantages are the exception rather than the rule (government made regulations, cost and revenue advantages ex production techniques and know how downward sloping learning curve can this accessed by competitors, customer captivity high switching cost )
- Some notes low cost labor and capital is rare and unlikely to be sustainable as labor and capital will move to where ever most efficiently used and push up cost of labors as those in the market compete
Valuing a franchise business
- Given the challenges growth poses for using asset based and epv being perpetual constant state as a valuation method we should look at returns in assessing franchise businesses
- Evaluating returns based on cash, organic growth and active growth
- Cash returns is taking the company’s sustainable earnings by market value for a sustainable earning yield then multiplying by the percent expected to be paid to shareholders through stock buybacks and dividends that gets you the cash return on current earning power the differential should be accounted by the organic and active growth of the business
- Organic growth will be enjoyed in markets where the player has a sustainable competitive advantage (pricing power) could also come from rising tide of the product or service offered (population growth, rising household incomes). Second is cost reduction improving efficiency this will raise profit margin in markets with enough barriers to entry this can add to organic growth value.
- A few ways to estimate organic growth: 1. Historical growth rate but need to keep in mind how this has been trending to the historical. 2. GDP growth with adjustments for where the product is sold (top down) 3 bottom up look at the foot traffic and capacity for growth
- Need to factor in the cost advantage as well to this organic growth get down to the unit economics for every dollar of growth how much working capital needs to be invested as well.
- Active investment growth needs to be measured by what management is investing the remaining retained earnings too. This is all about capital allocation what does management do with the retained earnings.
- You add these three factors up to get the returns you need to compare that return to alternatives to know what the best opportunity is for equities can look at cost of capital (WACC), returns relative to total market so spy dividend return + growth and 1/PE of spy + inflation
- Fade risk needs to be taken into account but estimimating this is so hard but basically using the rule of 72 divide by the number of years in the future where the franchise survival probability declines to 50%
- Dividend discount model is very similar to what we are talking about in terms of cash returns + growth but our calc accounts for sharebuybacks which ddm does not another factor is single share analysis doesn't take into account the overall enterprise
- Shortfalls of returns based analysis
- 1. Expectation of a constant future and fade risk being higher or lower
- This return calculation has a lot of short falls to consider plus math that is qualitatively valuable but quantitavily imperfect.
WD-40 Case study
- relatively stable business but saturated unlikely to grow much given low frequency of puchase but at the time in 1998 was trading at 18x in a market of of 22-23x but their historical multiple was 17-18 as well.
- First step assess the franchise
- - customer captivity through customer loyalty and abscense of technology change, low purchase price of product made search cost high no point in trying substitutes
- - This leads to economy of scale as any one who wants to enter their market would squeeze retailer margins and wd variable cost would outweigh them
- Valueing the business in 1998 take sustainable earning power and dividend by cost of capital
- This led to the equity being over valued but doesn’t take into account the franchise value. In order to do this we examine it based on the returns so cash returns for the business where 5% given 86% payout ratio on 5.7% sustainable earnings to market value
- Organic growth we take into account where the growth will come from and how much working capital investment will be necessary to support the growth (AR/inventory to sales and Ap/accrued liabilities to sales) see if the sustainable earnings can support this working capital need to sales to distributions. That leaves the remaining distributable amount for reinvestment
- Evaluate managements past m&a by assessing the return on capital invested by looking at EPV to their investment
Research strategy
- most important part in researcch is investigating the key assumptions that underlie your valuation
- Indirect information: who owns the shares? Understand their track record in the industry, what are insiders doing buying is more an indication than selling given their can be many reasons they are selling. Is management issuing equity could be a negative sign for future returns depending on the use of equity. A network of experts to understand differing views and lastly what is consensus looked at impassionatly creates opportunity to understand counter and for arguments stay rational.
- Direct information need to uncover the extent, durability and consequences of specific competitive advantage and how it relates to its industry
- management, activism, and catalyst:
- A true assessment of management requires 1. operational efficiency in controlling cost in marketing and product development 2. capital allocation decisions around growth focus on profitable growth not just growth for growth sake. 3. financial structure and distribution to shareholders 4. Human resource management (talent management)
- Most important is operational efficiency as this produces a moat of being the low cost winner
- Growth should only be done if it produce value above their cost this only happens from sustainable competitive advantage such as customer captivatity through distribution or software and expanding to adjanent markets through core advantages (customer captivity and economies of scale)
- critical issues in research:
- 1. 80/20 get to the critical prospect like everything there is diminishing returns in research but you got to balance it because you have to turn every stone to find that key insight
- 2. Focus on long term trends not predicting the timing, duration and magnitude of changes that’s harder than identifying stability
Risk management and building portfolio
- often times risk is decentralized in portfolios leading to an aggregate portfolio that follows the market and has frictional cost
- Wealth owners must centralize risk management and capital allocation decisions
- Variance as a measure of risk is broken because the returns are asymmetrical, investments are capped at a 100% downside but unlimited upside
- That's why Graham and Dodd focused on the downside risk of permanent impairment of capital
- Arises from 3 sources 1. overpaying for a security, 2. excessive leverage (leading to bankruptcy or loss of competitive positioning due to diversion), 3. Unanticipated adverse developments affecting financial position of issuing company (company level - failure of new product, expansion fails, competitor makes inroads on their business, wrong priorities by management)(industry level - new tech that undermines current economic position or value of its assets, regulator changes that whittle down profitability, adverse impact of globalization, irrational competition)
- Inflation that is stable should benefit real assets as they can charge more for rents etc and make it worse for fixed income investments
- Deflation should benefit fixed income
- Franchise businesses (ex coca cola, fico etc) should do well in both environments given protection from intensified competition in deflation and pricing power in inflation
- Three types of insurance for the portfolio: options, selective short sales, cash - cash is typically the most selected
Some thoughts:
- businesses protected from relentless competition (usually duopoly with successful coexistence or local monopolies without threat of government intervention)
- Companies taking market share in a profitable way (high roic)
- Shareholder focused management - efficient operations, value enhancing capital allocation and distribution of excess funds as dividends or share buybacks
-
January 15, 2018
It is the best book on Value investing I have seen.
It is a good review book, which put together all the different concepts together (margin of safety, intrinsic value, etc). It also has a satisfactory review of the key value investors, and you can judge for yourself that they might have quite different approaches within the value investing theme.
I did not like that different profiles for different investors not similarly structured. Some investment cases presentation is helpful, but sometimes dominated too much.
Quotes:
Most investors want to buy securities whose true worth is not reflected in the current market price of the shares. There is general agreement that the value of a company is the sum of the cash flows it will produce for investors over the life of the company, discounted back to the present. In many cases, however, this approach depends on estimating cash flows far into the future, well beyond the horizon of even the most prophetic analyst. Value investors since Graham have always preferred a bird in the hand-cash in the bank or some close equivalent-to the rosiest projection of future riches. Therefore, instead of relying on techniques that must make assumptions about events and conditions far into the future, value investors prefer to estimate the intrinsic value of a company by looking first at the assets and then at the current earnings power of a company.
A further advantage of the value investor's approach-first the assets, then the current earnings power, and finally and rarely the value of the potential growth-is that it gives the most authority to the elements of valuation that are most credible.
2 Searching for Value: Fish Where the Fish Are
The situation becomes most extreme toward the end of a reporting period, when managers window-dress their portfolios, dumping the stocks that have fallen in price and loading up on the past year's (or quarter's) successes. This pruning has the effect of driving up the price of currently successful stocks and depressing even further stocks that are already downtrodden. The end of the year has historically been a good month to pick up the value stocks that window-dressing managers have tossed out in order to avoid listing them in the year-end report.
A more thorough examination of the correlation of past performance with future return would reveal just the opposite: over a two-or three-year period, yesterday's laggards become tomorrow's leaders.
3 Valuation in Principle, Valuation in Practice
Three-Element Approach to Valuation: Assets, Earnings Power, and Profitable Growth
The second most reliable measure of a firm's intrinsic value is the second calculation made by Graham and Dodd, namely, the value of its current earnings, properly adjusted.
The traditional Graham and Dodd earnings assumptions are
(1) that current earnings, properly adjusted, correspond to sustainable levels of distributable cash flow; and
(2) that this earnings level remains constant for the indefinite future.
Using these assumptions, the equation for the earnings power value
(EPV) of a company is EPV = Adjusted Earnings x 1/R, where R is the current cost of capital. Because the cash flow is assumed to be constant, the growth rate G is zero.
The adjustments to earnings, which we discuss in greater detail in Chapter 5, include
1. Rectifying accounting misrepresentations, such as frequent "onetime" charges that are supposedly unconnected to normal operations; the adjustment consists of finding the average ratio that these charges bear to reported earnings before adjustments, annually, and reducing the current year's reported earnings before adjustment proportionally.
2. Resolving discrepancies between depreciation and amortization, as reported by the accountants, and the actual amount of reinvestment the company needs to make in order to restore a firm's assets at the end of the year to their level at the start of the year; the adjustment adds or subtracts this difference.
3. Taking into account the current position in the business cycle and other transient effects; the adjustment reduces earnings reported at the peak of the cycle and raises them if the firm is currently in a cyclical trough.
4. Considering other modifications we discuss in Chapter 5.
The goal is to arrive at an accurate estimate of the current distributable cash flow of the company by starting with earnings data and refining them. To repeat, we assume that this level of cash flow can be sustained and that it is not growing. Although the resulting earnings power value is somewhat less reliable than the pure asset-based valuation, it is considerably more certain than a full-blown present value calculation that assumes a rate of growth and a cost of capital many years in the future.
And while the equation for EPV looks like other multiple-based valuations we just criticized, it has the advantage of being based entirely on currently available information and is uncontaminated by more uncertain conjectures about the future.
We have ignored here the value of the future growth of earnings. But we are justified in paying no attention to it because in evaluating companies operating on a level playing field, with no competitive advantages or barriers to entry, growth has no value.
Element 3: The Value of Growth
When does growth contribute to intrinsic value? We have isolated the growth issue for two reasons. First, this third and last element of value is the most difficult to estimate, especially if we are trying to project it for a long period into the future.
4 Valuing the Assets: From Book Value to Reproduction Costs
The surest method for assigning a value to the license or franchise is to see what similar rights have sold for in the private market, that is, to a knowledgeable buyer who is paying for the whole business.
There are ways to compare situations that initially look dissimilar. There is almost always a "per" number: price per subscriber, per regional population, per caseload, per stadium seat. Recent sales in the private market provide a benchmark for valuing the license or franchise of the company under analysis.
5 Earnings Power Value: Assets Plus Franchise
Franchise only exists where a firm benefits from barriers to entry that keep out potential competitors or insure that if they choose to enter, they will operate at a competitive disadvantage relative to the incumbents. The competitive advantages that the incumbents enjoy need to be identifiable and structural. Good management is certainly an advantage, but there is nothing built in to the competitive situation to guarantee that one company's superiority on the talent count will endure over time. Structural competitive advantages come in only a few forms: exclusive governmental licenses, consumer (demand) preferences, a cost (supply) position based on long-lived patents or other durable superiorities, and the combination of economies of scale thanks to a leading share in the relevant market with consumer preference.
Spotting franchises is a difficult skill-one that takes time and work to master.
They will buy growth only at a discount from its estimated value large enough to make up for the greater uncertainty in valuation. The ideal price is zero: Pay in full for the current assets or earnings power and get the growth for free.
Equation for the present value of a growing firm, which is where F is the growth factor.
Appendix: Valuation Algebra: Return on Capital, Cost of Capital, and Growth
Whenever cash flows increase at a constant rate, it is possible to calculate the present value (PV) of this stream with the following formula: where R is the cost of capital and G is the rate of growth. If the cost of capital is 20 percent, then for zero growth the equation is The equation for the growing company is
M = PV/EPV, with M defined as the growth-related value multiplier. In this expression,
PV= CF x (ROIC-G)/(R-G)
EPV= CF x ROIC/R
8 Constructing the Portfolio: Risk, Diversification, and Default Strategies
Margin of safety requirement provides a mechanism for reducing risk that is totally distinct from diversification. Buying a company for substantially less than tangible book value or the well-tested value of its earnings is already a low-risk strategy. Using a valuation based on assets as a check on a valuation based on earnings power, all the while refusing to pay much if anything for the prospects of growth, further limits risk. If an ordinary portfolio (one not selected on value grounds) needs 20 or 30 names to be adequately diversified, then perhaps the margin of safety portfolio needs only 10 or 15.
Value investors also control risk by continually challenging their own judgments. Since many of their decisions run against the grain of prevailing Wall Street sentiment, they look for some credible confirmation of their opinions. For example, if knowledgeable insiders are buying the securities even as the market ignores the stock, the investor gains a measure of assurance.
second confirmation comes from discovering that other highly respected investors are taking similar positions.
Position limits are an additional safeguard. Investors establish policies that limit the amount of the portfolio they will commit to a single security. They can have one limit for the initial purchase and another standard for securities within the portfolio. If a position appreciates above those limits, it is a signal to trim back by selling into strength. This is certainly a form of diversification, but it is designed more to limit the exposure to any particular investment than to mimic the behavior of the broad market.
9 Warren Buffett: Investing Is Allocating Capital
Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.
The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised.
Though the mathematical calculations required to evaluate equities are not difficult, an analyst-even one who is experienced and intelligent-can easily go wrong in estimating future "coupons." At Berkshire, we attempt to deal with this problem in two ways. First, we try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we're not smart enough to predict future cash flows. Incidentally, that shortcoming doesn't bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes.
Second, and equally important, we insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we're not interested in buying.
Risk is "the possibility of loss or injury."
The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.
11 Glenn Greenberg: Investigate, Concentrate, and-Watch That Basket
Chieftain partners will not begin to buy a stock unless they are willing to put at least 5 per cent of their assets into it. This is an antidiversification device, and it has a manifold influence on their entire investment process. First, they need to have two types of confidence in the selection: confidence in their ability to understand the company, its industry, and its business prospects; and confidence in the company, that it will continue to perform well and increase the wealth of its shareholders.
Chieftain portfolio has far fewer than the 20 names that a strict 5 percent rule might imply. The partners normally hold 8 to 10 stocks in their accounts, and they are willing to invest heavily in a situation that they are thoroughly convinced will work out for them. To improve their odds, all four professionals in the firm study the same stocks, and they have to agree before they buy a share. If diversification is a substitute for knowledge, then information and understanding should work in reverse.
Chieftain Capital manages $3 billion for its clients. If it normally holds shares in 10 or even fewer companies, then on average it needs to put hundreds of millions into any one name. Because great situations are so difficult to find, they are prepared to buy 20 percent or more of any one company. While there are around 1,500 or more companies large enough for them to own, their "good business" requirement probably shrinks that list by 80 percent, leaving them with no more than 300 possible
Chieftain is not attracted to turnaround companies or cyclicals, where a successful investment depends on timing. He does not believe in speculating that an underperforming company will be taken over, because most managements resist selling out.
Before the arrival of the personal computer and the electronic spreadsheet, he and his partner would analyze a company by isolating its business segments and projecting revenue and expenses no more than two or three years into the future. By assuming that it would grow steadily from then on, they could calculate its current value by discounting that cash flow back to the present, using only a hand calculator. Now, with spreadsheets, they can make their projections more detailed and carry them forward further in time. Discounted cash flow analysis, a method about which we expressed some reservations in the first part of this book, is Greenberg's valuation technique of choice for all the investments he makes.
He is only interested in companies with stable earnings and relatively predictable cash flows.
And he is careful to make sure that all of the assumptions that are built into a present value analysis are reasonable and conservative: sales growth rates; profit margins; the market prices of assets such as oil, gas, and other fuels; capital expenditure requirements; and discount rates. Common sense serves as the touchstone against which all spreadsheet projections are assessed. He uses the model; he doesn't let it control him.
The real value of doing all the work required for a full discounted cash flow analysis is that it forces the investor to think long and hard about all the factors that will affect the future of the business, including the risks it may face that are currently unexpected and unforeseen.
With few stocks in their clients' portfolios, each of them purchased as a long-term investment, the partners of Chieftain do not need to find many new companies to add to their list. In some years, they buy no additional names, in other years three or four. This slow turnover leaves them time to keep thoroughly informed about the firms they do own, a necessity given the large stakes they maintain in each of their companies. All the partners go to the companies' meetings; all of them scrutinize the quarterly filings; and all of them keep current about the industry. They talk with management regularly, and they read the trade journals and other relevant material. In addition to the superior returns we described, their work has earned them the respect of the executives with whom they speak. They have been told by management that they understand the company better than all sellside analysts covering it.
Greenberg readily acknowledges, they make plenty of mistakes and are often quite inexact in their estimates of a company's revenues and earnings. They tend to err on the high side, which puts them in the camp of most analysts. How then have they done so well? For one thing, as value investors, they have not based their investment decisions on expectations of perfection. They do not buy high multiple stocks for whom an earnings disappointment can mean a punishing drop
The companies in their portfolio are sound enough to recover from short-term problems. As a consequence, the mistakes they have made have not buried them. Their poor investments, Greenberg says, have resulted more in dead money than fatal declines.
12 Robert H. Heilbrunn: Investing in Investors
Heilbrunn’s investment strategy based on this information is to buy stocks when they sell within the lower portion of their historical P/E multiple range, within the higher portion of their dividend yield range, or both. By establishing the ranges with precision, this approach provides a check on the emotions that can distort investment judgment, both the exuberance engendered by a rising market and the despair occasioned by a falling one.
13 Seth Klarman: Distressed Sellers, Absent Buyers
14 Michael Price: Discipline, Patience, Focus, and Power
Michael Price certainly does not rely on sell-side research, but he is willing to use it for a convenient summary of a complicated firm's business segments and as a check on his own valuation approach.
To estimate the intrinsic value of a firm, Price asks one question: How much is a knowledgeable buyer willing to pay for the whole company? He finds his answer by studying the mergers and acquisitions transactions in which companies are bought and sold.
how much they are insured for,
Don't deviate from the valuation standards, especially as the sirens of momentum are enticing the unwary.
second quality is patience: After the analysis has been completed and the intrinsic value is determined, don't chase the stock. It is important to wait for the market to offer a price with a discount large enough to allow for a margin of safety.
third virtue is focus: Don't be distracted by global predictions or macro forecasts, either by listening to them or making them yourself. It is much easier to understand a security than an economy, and the way to profit is by using that understanding.
15 Walter and Edwin Schloss:
Keep It Simple, and Cheap
Schloss are minimalists. Their office-Castle Schloss has one room-is spare; they don't visit companies; they rarely speak to management; they don't speak to analysts; and they don't use the Internet. they limit their conversations.
The Schlosses would rather trust their own analysis and their long-standing commitment to buying cheap stocks.
This approach leads them to focus almost exclusively on the published financial statements that public firms must produce each quarter. They start by looking at the balance sheet.
succinct response: We buy cheap stocks. Identifying "cheap" means comparing price with value. What generally brings a stock to the Schlosses' attention is that the price has fallen.
They scrutinize the new lows list to find stocks that have come down in price.
When they find a cheap stock, they may start to buy even before they have completed their research.
Schlosses believe that the only way really to know a security is to own it, so they sometimes stake out their initial position and then send for the financial statements. The market today moves so fast that they are almost forced to act quickly.
company's whose shares can be bought for less than the value of the assets will, more often than
It is a good review book, which put together all the different concepts together (margin of safety, intrinsic value, etc). It also has a satisfactory review of the key value investors, and you can judge for yourself that they might have quite different approaches within the value investing theme.
I did not like that different profiles for different investors not similarly structured. Some investment cases presentation is helpful, but sometimes dominated too much.
Quotes:
Most investors want to buy securities whose true worth is not reflected in the current market price of the shares. There is general agreement that the value of a company is the sum of the cash flows it will produce for investors over the life of the company, discounted back to the present. In many cases, however, this approach depends on estimating cash flows far into the future, well beyond the horizon of even the most prophetic analyst. Value investors since Graham have always preferred a bird in the hand-cash in the bank or some close equivalent-to the rosiest projection of future riches. Therefore, instead of relying on techniques that must make assumptions about events and conditions far into the future, value investors prefer to estimate the intrinsic value of a company by looking first at the assets and then at the current earnings power of a company.
A further advantage of the value investor's approach-first the assets, then the current earnings power, and finally and rarely the value of the potential growth-is that it gives the most authority to the elements of valuation that are most credible.
2 Searching for Value: Fish Where the Fish Are
The situation becomes most extreme toward the end of a reporting period, when managers window-dress their portfolios, dumping the stocks that have fallen in price and loading up on the past year's (or quarter's) successes. This pruning has the effect of driving up the price of currently successful stocks and depressing even further stocks that are already downtrodden. The end of the year has historically been a good month to pick up the value stocks that window-dressing managers have tossed out in order to avoid listing them in the year-end report.
A more thorough examination of the correlation of past performance with future return would reveal just the opposite: over a two-or three-year period, yesterday's laggards become tomorrow's leaders.
3 Valuation in Principle, Valuation in Practice
Three-Element Approach to Valuation: Assets, Earnings Power, and Profitable Growth
The second most reliable measure of a firm's intrinsic value is the second calculation made by Graham and Dodd, namely, the value of its current earnings, properly adjusted.
The traditional Graham and Dodd earnings assumptions are
(1) that current earnings, properly adjusted, correspond to sustainable levels of distributable cash flow; and
(2) that this earnings level remains constant for the indefinite future.
Using these assumptions, the equation for the earnings power value
(EPV) of a company is EPV = Adjusted Earnings x 1/R, where R is the current cost of capital. Because the cash flow is assumed to be constant, the growth rate G is zero.
The adjustments to earnings, which we discuss in greater detail in Chapter 5, include
1. Rectifying accounting misrepresentations, such as frequent "onetime" charges that are supposedly unconnected to normal operations; the adjustment consists of finding the average ratio that these charges bear to reported earnings before adjustments, annually, and reducing the current year's reported earnings before adjustment proportionally.
2. Resolving discrepancies between depreciation and amortization, as reported by the accountants, and the actual amount of reinvestment the company needs to make in order to restore a firm's assets at the end of the year to their level at the start of the year; the adjustment adds or subtracts this difference.
3. Taking into account the current position in the business cycle and other transient effects; the adjustment reduces earnings reported at the peak of the cycle and raises them if the firm is currently in a cyclical trough.
4. Considering other modifications we discuss in Chapter 5.
The goal is to arrive at an accurate estimate of the current distributable cash flow of the company by starting with earnings data and refining them. To repeat, we assume that this level of cash flow can be sustained and that it is not growing. Although the resulting earnings power value is somewhat less reliable than the pure asset-based valuation, it is considerably more certain than a full-blown present value calculation that assumes a rate of growth and a cost of capital many years in the future.
And while the equation for EPV looks like other multiple-based valuations we just criticized, it has the advantage of being based entirely on currently available information and is uncontaminated by more uncertain conjectures about the future.
We have ignored here the value of the future growth of earnings. But we are justified in paying no attention to it because in evaluating companies operating on a level playing field, with no competitive advantages or barriers to entry, growth has no value.
Element 3: The Value of Growth
When does growth contribute to intrinsic value? We have isolated the growth issue for two reasons. First, this third and last element of value is the most difficult to estimate, especially if we are trying to project it for a long period into the future.
4 Valuing the Assets: From Book Value to Reproduction Costs
The surest method for assigning a value to the license or franchise is to see what similar rights have sold for in the private market, that is, to a knowledgeable buyer who is paying for the whole business.
There are ways to compare situations that initially look dissimilar. There is almost always a "per" number: price per subscriber, per regional population, per caseload, per stadium seat. Recent sales in the private market provide a benchmark for valuing the license or franchise of the company under analysis.
5 Earnings Power Value: Assets Plus Franchise
Franchise only exists where a firm benefits from barriers to entry that keep out potential competitors or insure that if they choose to enter, they will operate at a competitive disadvantage relative to the incumbents. The competitive advantages that the incumbents enjoy need to be identifiable and structural. Good management is certainly an advantage, but there is nothing built in to the competitive situation to guarantee that one company's superiority on the talent count will endure over time. Structural competitive advantages come in only a few forms: exclusive governmental licenses, consumer (demand) preferences, a cost (supply) position based on long-lived patents or other durable superiorities, and the combination of economies of scale thanks to a leading share in the relevant market with consumer preference.
Spotting franchises is a difficult skill-one that takes time and work to master.
They will buy growth only at a discount from its estimated value large enough to make up for the greater uncertainty in valuation. The ideal price is zero: Pay in full for the current assets or earnings power and get the growth for free.
Equation for the present value of a growing firm, which is where F is the growth factor.
Appendix: Valuation Algebra: Return on Capital, Cost of Capital, and Growth
Whenever cash flows increase at a constant rate, it is possible to calculate the present value (PV) of this stream with the following formula: where R is the cost of capital and G is the rate of growth. If the cost of capital is 20 percent, then for zero growth the equation is The equation for the growing company is
M = PV/EPV, with M defined as the growth-related value multiplier. In this expression,
PV= CF x (ROIC-G)/(R-G)
EPV= CF x ROIC/R
8 Constructing the Portfolio: Risk, Diversification, and Default Strategies
Margin of safety requirement provides a mechanism for reducing risk that is totally distinct from diversification. Buying a company for substantially less than tangible book value or the well-tested value of its earnings is already a low-risk strategy. Using a valuation based on assets as a check on a valuation based on earnings power, all the while refusing to pay much if anything for the prospects of growth, further limits risk. If an ordinary portfolio (one not selected on value grounds) needs 20 or 30 names to be adequately diversified, then perhaps the margin of safety portfolio needs only 10 or 15.
Value investors also control risk by continually challenging their own judgments. Since many of their decisions run against the grain of prevailing Wall Street sentiment, they look for some credible confirmation of their opinions. For example, if knowledgeable insiders are buying the securities even as the market ignores the stock, the investor gains a measure of assurance.
second confirmation comes from discovering that other highly respected investors are taking similar positions.
Position limits are an additional safeguard. Investors establish policies that limit the amount of the portfolio they will commit to a single security. They can have one limit for the initial purchase and another standard for securities within the portfolio. If a position appreciates above those limits, it is a signal to trim back by selling into strength. This is certainly a form of diversification, but it is designed more to limit the exposure to any particular investment than to mimic the behavior of the broad market.
9 Warren Buffett: Investing Is Allocating Capital
Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.
The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised.
Though the mathematical calculations required to evaluate equities are not difficult, an analyst-even one who is experienced and intelligent-can easily go wrong in estimating future "coupons." At Berkshire, we attempt to deal with this problem in two ways. First, we try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we're not smart enough to predict future cash flows. Incidentally, that shortcoming doesn't bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes.
Second, and equally important, we insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we're not interested in buying.
Risk is "the possibility of loss or injury."
The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.
11 Glenn Greenberg: Investigate, Concentrate, and-Watch That Basket
Chieftain partners will not begin to buy a stock unless they are willing to put at least 5 per cent of their assets into it. This is an antidiversification device, and it has a manifold influence on their entire investment process. First, they need to have two types of confidence in the selection: confidence in their ability to understand the company, its industry, and its business prospects; and confidence in the company, that it will continue to perform well and increase the wealth of its shareholders.
Chieftain portfolio has far fewer than the 20 names that a strict 5 percent rule might imply. The partners normally hold 8 to 10 stocks in their accounts, and they are willing to invest heavily in a situation that they are thoroughly convinced will work out for them. To improve their odds, all four professionals in the firm study the same stocks, and they have to agree before they buy a share. If diversification is a substitute for knowledge, then information and understanding should work in reverse.
Chieftain Capital manages $3 billion for its clients. If it normally holds shares in 10 or even fewer companies, then on average it needs to put hundreds of millions into any one name. Because great situations are so difficult to find, they are prepared to buy 20 percent or more of any one company. While there are around 1,500 or more companies large enough for them to own, their "good business" requirement probably shrinks that list by 80 percent, leaving them with no more than 300 possible
Chieftain is not attracted to turnaround companies or cyclicals, where a successful investment depends on timing. He does not believe in speculating that an underperforming company will be taken over, because most managements resist selling out.
Before the arrival of the personal computer and the electronic spreadsheet, he and his partner would analyze a company by isolating its business segments and projecting revenue and expenses no more than two or three years into the future. By assuming that it would grow steadily from then on, they could calculate its current value by discounting that cash flow back to the present, using only a hand calculator. Now, with spreadsheets, they can make their projections more detailed and carry them forward further in time. Discounted cash flow analysis, a method about which we expressed some reservations in the first part of this book, is Greenberg's valuation technique of choice for all the investments he makes.
He is only interested in companies with stable earnings and relatively predictable cash flows.
And he is careful to make sure that all of the assumptions that are built into a present value analysis are reasonable and conservative: sales growth rates; profit margins; the market prices of assets such as oil, gas, and other fuels; capital expenditure requirements; and discount rates. Common sense serves as the touchstone against which all spreadsheet projections are assessed. He uses the model; he doesn't let it control him.
The real value of doing all the work required for a full discounted cash flow analysis is that it forces the investor to think long and hard about all the factors that will affect the future of the business, including the risks it may face that are currently unexpected and unforeseen.
With few stocks in their clients' portfolios, each of them purchased as a long-term investment, the partners of Chieftain do not need to find many new companies to add to their list. In some years, they buy no additional names, in other years three or four. This slow turnover leaves them time to keep thoroughly informed about the firms they do own, a necessity given the large stakes they maintain in each of their companies. All the partners go to the companies' meetings; all of them scrutinize the quarterly filings; and all of them keep current about the industry. They talk with management regularly, and they read the trade journals and other relevant material. In addition to the superior returns we described, their work has earned them the respect of the executives with whom they speak. They have been told by management that they understand the company better than all sellside analysts covering it.
Greenberg readily acknowledges, they make plenty of mistakes and are often quite inexact in their estimates of a company's revenues and earnings. They tend to err on the high side, which puts them in the camp of most analysts. How then have they done so well? For one thing, as value investors, they have not based their investment decisions on expectations of perfection. They do not buy high multiple stocks for whom an earnings disappointment can mean a punishing drop
The companies in their portfolio are sound enough to recover from short-term problems. As a consequence, the mistakes they have made have not buried them. Their poor investments, Greenberg says, have resulted more in dead money than fatal declines.
12 Robert H. Heilbrunn: Investing in Investors
Heilbrunn’s investment strategy based on this information is to buy stocks when they sell within the lower portion of their historical P/E multiple range, within the higher portion of their dividend yield range, or both. By establishing the ranges with precision, this approach provides a check on the emotions that can distort investment judgment, both the exuberance engendered by a rising market and the despair occasioned by a falling one.
13 Seth Klarman: Distressed Sellers, Absent Buyers
14 Michael Price: Discipline, Patience, Focus, and Power
Michael Price certainly does not rely on sell-side research, but he is willing to use it for a convenient summary of a complicated firm's business segments and as a check on his own valuation approach.
To estimate the intrinsic value of a firm, Price asks one question: How much is a knowledgeable buyer willing to pay for the whole company? He finds his answer by studying the mergers and acquisitions transactions in which companies are bought and sold.
how much they are insured for,
Don't deviate from the valuation standards, especially as the sirens of momentum are enticing the unwary.
second quality is patience: After the analysis has been completed and the intrinsic value is determined, don't chase the stock. It is important to wait for the market to offer a price with a discount large enough to allow for a margin of safety.
third virtue is focus: Don't be distracted by global predictions or macro forecasts, either by listening to them or making them yourself. It is much easier to understand a security than an economy, and the way to profit is by using that understanding.
15 Walter and Edwin Schloss:
Keep It Simple, and Cheap
Schloss are minimalists. Their office-Castle Schloss has one room-is spare; they don't visit companies; they rarely speak to management; they don't speak to analysts; and they don't use the Internet. they limit their conversations.
The Schlosses would rather trust their own analysis and their long-standing commitment to buying cheap stocks.
This approach leads them to focus almost exclusively on the published financial statements that public firms must produce each quarter. They start by looking at the balance sheet.
succinct response: We buy cheap stocks. Identifying "cheap" means comparing price with value. What generally brings a stock to the Schlosses' attention is that the price has fallen.
They scrutinize the new lows list to find stocks that have come down in price.
When they find a cheap stock, they may start to buy even before they have completed their research.
Schlosses believe that the only way really to know a security is to own it, so they sometimes stake out their initial position and then send for the financial statements. The market today moves so fast that they are almost forced to act quickly.
company's whose shares can be bought for less than the value of the assets will, more often than
This entire review has been hidden because of spoilers.
January 17, 2023
Value Investing: From Graham to Buffett and Beyond
Una propuesta provocadora:
Obtener los conocimientos del Value Investing en un libro por $22, de la mano de los representantes más notables de la Universidad de Columbia; o seguir el curso online de educación ejecutiva de la misma institución con un contenido idéntico, por un costo que asciende a $3,000.
Un verdadero inversor en valor escogería la primera opción.
El libro, en su segunda edición, es una actualización contemporánea de la metodología que popularizó Warren Buffett. De hecho, existe material inacabable en internet cuando uno quiere ahondar sobre los fundamentos y la aplicación del Value Investing.
Eso sí, un aviso de precaución al tratar de abordar este manual. No lo recomendaría para personas con un nivel básico o intermedio en finanzas o valorización de empresas. Contar con cierto recorrido en la terminología financiera basado en la experiencia profesional ayudará en conectar los puntos que los autores desarrollan.
Tres comentarios que resalto de mi lectura:
1. Barreras de entrada.- Concepto clave para entender la existencia de las ventajas competitivas sostenibles (“moats”). El objetivo aspiracional de toda empresa es convertirse en monopolio, o al menos asegurar que la competencia vigente y futura no afecte significativamente el retorno sobre el capital. Dichas barreras deben ser ejecutadas conscientemente y pueden darse por múltiples razones: (i) tecnología propia, (ii) acceso preferente a consumidores, (iii) economías de escala, (iv) condiciones particulares de oferta, entre otros.
2. Metodología de triangulación.- (i) la valorización de activos, (ii) el earning power value y (iii) el return approach son componentes de un método integral que nos permite conocer el potencial de valor de una empresa. Fuera de los conocimientos específicos contables y supuestos generales utilizados, el sistema propuesto evita a toda costa asumir crecimiento a futuro, siendo muy conservador en su resultado. Pese a los puntos favorables que los autores resaltan en su metodología, mi experiencia es que esta herramienta no es usada por gran parte de los participantes del mercado financiero.
3. Casuística detallada.- Dado que la metodología de triangulación exige profundidad en el conocimiento sectorial y una alta aptitud en el uso de información financiero-contable, los autores desarrollan ejemplos prácticos que sirven como guía para aplicar correctamente la metodología (ej. Hudson General, Magna International, Intel).
Una propuesta provocadora:
Obtener los conocimientos del Value Investing en un libro por $22, de la mano de los representantes más notables de la Universidad de Columbia; o seguir el curso online de educación ejecutiva de la misma institución con un contenido idéntico, por un costo que asciende a $3,000.
Un verdadero inversor en valor escogería la primera opción.
El libro, en su segunda edición, es una actualización contemporánea de la metodología que popularizó Warren Buffett. De hecho, existe material inacabable en internet cuando uno quiere ahondar sobre los fundamentos y la aplicación del Value Investing.
Eso sí, un aviso de precaución al tratar de abordar este manual. No lo recomendaría para personas con un nivel básico o intermedio en finanzas o valorización de empresas. Contar con cierto recorrido en la terminología financiera basado en la experiencia profesional ayudará en conectar los puntos que los autores desarrollan.
Tres comentarios que resalto de mi lectura:
1. Barreras de entrada.- Concepto clave para entender la existencia de las ventajas competitivas sostenibles (“moats”). El objetivo aspiracional de toda empresa es convertirse en monopolio, o al menos asegurar que la competencia vigente y futura no afecte significativamente el retorno sobre el capital. Dichas barreras deben ser ejecutadas conscientemente y pueden darse por múltiples razones: (i) tecnología propia, (ii) acceso preferente a consumidores, (iii) economías de escala, (iv) condiciones particulares de oferta, entre otros.
2. Metodología de triangulación.- (i) la valorización de activos, (ii) el earning power value y (iii) el return approach son componentes de un método integral que nos permite conocer el potencial de valor de una empresa. Fuera de los conocimientos específicos contables y supuestos generales utilizados, el sistema propuesto evita a toda costa asumir crecimiento a futuro, siendo muy conservador en su resultado. Pese a los puntos favorables que los autores resaltan en su metodología, mi experiencia es que esta herramienta no es usada por gran parte de los participantes del mercado financiero.
3. Casuística detallada.- Dado que la metodología de triangulación exige profundidad en el conocimiento sectorial y una alta aptitud en el uso de información financiero-contable, los autores desarrollan ejemplos prácticos que sirven como guía para aplicar correctamente la metodología (ej. Hudson General, Magna International, Intel).
February 22, 2018
I read this book because I'm currently enrolled in Greenwald's Value Investing course and wanted to dig a bit deeper. This book is very good for anyone interested in the basic precepts of value investing (basically, looking for good companies that are currently out of favor with the stock market). Bruce gives a good summary of the traditional value approach as devised by Benjamin Graham and David Dodd, and also profiles a handful of more contemporary value investors (Warren Buffett, Mario Gabelli, etc.). It was interesting to read about the various practical approaches to value investing to get beyond just theory.
I think I gave only 3 stars because I may be a bit burnt out by Greenwald (in his class and recently read his very good Competition Demystified: A Radically Simplified Approach to Business Strategy). I may have preferred more if I was newer to the material. There are some really good case studies, and he clearly articulates concepts like Warren Buffett's "franchise businesses" and Mario Gabelli's idea of a "Private Market Value" using businesses like WD-40 (you have a can in your home and you may not even know it). This book is good for anyone who wants a methodical framework for assessing the value of equity securities. A word of caution, however, the behavioral tantrums of "Mr. Market" make value investing much harder in practice!
I think I gave only 3 stars because I may be a bit burnt out by Greenwald (in his class and recently read his very good Competition Demystified: A Radically Simplified Approach to Business Strategy). I may have preferred more if I was newer to the material. There are some really good case studies, and he clearly articulates concepts like Warren Buffett's "franchise businesses" and Mario Gabelli's idea of a "Private Market Value" using businesses like WD-40 (you have a can in your home and you may not even know it). This book is good for anyone who wants a methodical framework for assessing the value of equity securities. A word of caution, however, the behavioral tantrums of "Mr. Market" make value investing much harder in practice!
October 10, 2020
This book has been an eye opener to me. For all those people who keep preaching on Discounted Cash Flow (DCF) valuation or other relative valuation techniques using P/E, P/B etc, Greenwald talks about the uncertainty of future earnings. Tools like DCF suffer from a major problem - the need to predict future earnings which is difficult to predict even for the company stakeholders. Greenwald's method looks at what it takes to value a company if it wants to sustain without any growth.
Chapters 4 - 7 are a must read for any budding investor. It starts out with the most defensive method of investing which tries to value the reproduction cost of assets in the balance sheet. Then we are introduced to the Earnings Power Value (EPV) method - which tries to put a price on the Moat / Franchise Value. Finally one can try to apply a growth factor if one finds that the company truly has a moat and is in a growth phase.
If you are new to the world of value investing, I would suggest to pick up Peter Lynch or Pat Dorsey before attempting to read this book.
Chapters 4 - 7 are a must read for any budding investor. It starts out with the most defensive method of investing which tries to value the reproduction cost of assets in the balance sheet. Then we are introduced to the Earnings Power Value (EPV) method - which tries to put a price on the Moat / Franchise Value. Finally one can try to apply a growth factor if one finds that the company truly has a moat and is in a growth phase.
If you are new to the world of value investing, I would suggest to pick up Peter Lynch or Pat Dorsey before attempting to read this book.
April 11, 2023
A comprehensive and authoritative resource on value investing, this book is a perceptive and all-encompassing book that adeptly deconstructs the tactics and methodologies employed by some of the most accomplished investors globally. The authors build on the principles devised by Benjamin Graham while also illustrating the progression of value investing through the experiences of Warren Buffett and other eminent investors.
The book's potency lies in its ability to merge theoretical concepts with practical illustrations, providing readers with actionable guidance on stock analysis, pinpointing undervalued businesses, and making well-informed investment choices. Additionally, the authors confront prevalent misconceptions and stumbling blocks in value investing, rendering this book a priceless asset for novices and experienced investors alike.
Deservingly receiving a 5-star rating.
The book's potency lies in its ability to merge theoretical concepts with practical illustrations, providing readers with actionable guidance on stock analysis, pinpointing undervalued businesses, and making well-informed investment choices. Additionally, the authors confront prevalent misconceptions and stumbling blocks in value investing, rendering this book a priceless asset for novices and experienced investors alike.
Deservingly receiving a 5-star rating.
December 29, 2014
If you consider yourself a hardcore value investor, and really want to delve deep into the nuts and bolts of the methodology, then this is the supreme guidebook for you. There are several methods you'll read in this book, which you will find nowhere else. A great example of this would be the theory of attaining a company's real earnings power by excluding advertising & marketing costs related to growth. In other words, what would the company earn if it didn't have any expenses on facilitating growth. There are plenty of other tweaks and suggestions that the authors offer when it comes to delving into numbers like depreciation, R&D, and capital expenditures. Included in the book are examples of the theory put into practice, which greatly helps the learning process.
April 23, 2015
I found the investor profiles in the third section more useful than the rest.
Some of the earlier chapters are followed by short appendices, those were helpful.
In some cases, the approaches discussed involve investing enough money in a business to have control over its direction which isn't practically useful for me.
Also, published in 2001, it felt dated as it heralded investment research strategies used before the internet and thus financial data was widely available. Even the book often admits that finding businesses that are like the ones found by the great investors discussed and, this is key, not everyone else, are hard to come by today.
Some of the earlier chapters are followed by short appendices, those were helpful.
In some cases, the approaches discussed involve investing enough money in a business to have control over its direction which isn't practically useful for me.
Also, published in 2001, it felt dated as it heralded investment research strategies used before the internet and thus financial data was widely available. Even the book often admits that finding businesses that are like the ones found by the great investors discussed and, this is key, not everyone else, are hard to come by today.
November 18, 2015
The first two parts are very important for value investors to read and understand in framing financials in terms of investment opportunity. The last part about the various investment managers is just OK - great investors talking about good picks and their process. These are interesting tales, but not always easy to replicate in real life. Every now and then there were good nuggets in Part 3 about process. Otherwise, the first part has great, applicable tools for the investor to use prospectively, which is what makes this book a great investment book.
January 25, 2016
Este libro ofrece distintas ideas acerca del "value investing" y la evolución que este ha tenido a lo largo de los años. Hace un especial énfasis en las compañías con problemas y las que están en la fase de crecimiento desde el punto de vista de los inversores más famosos que son proclives a ésta filosofía.
August 21, 2015
This may be the modern book that a newbie should buy and learn value investing from.
His mathematical concepts of growth and ROC are worth a read but dont fit my style.
The mini profiles at the end of the book are good fun.
And the book is full of small examples which would help a student.
Rather useless for someone who is already a value investor.
His mathematical concepts of growth and ROC are worth a read but dont fit my style.
The mini profiles at the end of the book are good fun.
And the book is full of small examples which would help a student.
Rather useless for someone who is already a value investor.
October 12, 2015
The book is good to read for understanding the value investing techniques. It compares the investment technique of many well-known investors. It is not very well written but must to read if you have not read good material on this topic. The book loses the interest of reader after a while.
September 17, 2014
Outstanding. Will re-read a few more times.
July 18, 2015
Great introduction to an updated value investing approach! Very good supplemental to any value investing course.
January 6, 2016
very good: most value-oriented books are mostly marketing gimmicks, this one is an actual overview. mini-bios at the end (last 100 pgs) are a plus.
June 15, 2015
This is the richest book I've read on value investing. An absolute treat for the brains
Currently reading
May 17, 2025Using Kenneth French market to book data the return of a portfolio that was along the cheapest 30% of stocks and short the most expensive 30% is zero cost portfolio before transaction fee fees had a compound annual return of 3.35% from 1927 through 2018 on the gross amount invested in each bucket for an overall portfolio requiring known at investment. Page 9.
More than 80% of active fun managers under perform their market punch mark over a 510 and 15. Ending in June 2018. And not 15. The S&P 529.3% a year; the cheapest Quinn tile of stock sorted by earnings to price Returned 11.8%. Page 10.
Value investors regard price fluctuations as opportunities to buy or sell, not as accurate estimates of the intrinsic worth of the security. Page 14.
The future returns a portfolio is organized by market to book ratios increase steadily with the degree of cheap. The cheapest sells bucket of stocks often see 2/3 of the companies go bankrupt. But the ones that do survive do so well relative to their very low starting prices that the ugliest portfolios are the best performing among all the buckets. Portfolios of ugly, disappointing, obscure and boring stocks repeatedly generated higher returns in both the market has a hole and more strikingly portfolios of attractive, highly profitable well known in glamorous stocks. Page 22.
Overall, the statistical evidence, both for the United States and overseas markets, paints or remarkably consistent picture. Embracing stocks that are ugly, boring, obscure, disappointing in there for cheap has historically been the best way to buy stocks in which you are likely to be on the right side of the trade these are the stocks that I’ve performed the market as a whole. The uglier, more boring, more obscure, more disappointing in therefore usually the cheaper the stock the better the returns have been. Page 25
Greenwald talks about the basic human instinct that most have to get rich quick. He compares investing in glamour stocks to lottery tickets that hold out the promise of spectacularly high returns. Because of the appeal so investors are willing to pay rationally high price relative to their fundamental Values. Page 26.
The issue of size bias is more important and more interesting.
Many funds cannot invest in small companies, either because their mandates do not allow it or, more frequently, because they have too much money to manage and small companies just can't absorb enough of it to make it worthwhile. If a diversified investment company-most mutual funds—with $10 billion to invest wants to own stock in 100 companies, it needs on average to buy $100 million in each. Since the fund does not want and is often not allowed to own more than 10% of any company's stock, this limits the universe of investment choices to firms with market capitalization of $1 billion or more. The specific sizes of funds, the market capitalization of suitable firms, and the percentage of ownership will vary, but the impact of company size persists. Many funds simply cannot buy shares in small companies. For similar reasons, investment analysts within institutions will also concentrate on large capitalization opportunities. An insight into a $40 billion company that can absorb a $2 billion investment will be worth far more than an equivalent insight into a $400 million firm that can absorb only $20 million. The consequence is that coverage of and demand for small company shares will tend, all other things being equal, to be below that of large company shares, and small company stocks should be cheaper. 18 Hence, the shares in small companies are cheaper, all other things being equal, than shares in large companies. Among the "all other things" that need to be held constant, growth prospects are the most important.
Small companies typically have the opportunity to grow faster than large ones, which already control major segments of the markets in industries that are likely to be well developed. Page 31
Other business characteristics may have a more ambiguous impact on multiples. Good managements, for example, should enhance value per unit of cash flow. They will operate more carefully, lowering risk, and allocate retained earnings more effectively, enhancing future returns.
Still, overall future business performance will depend on the quality of management in the future, and how that compares to the people presently in charge. Here careful reasoning produces counterintuitive conclusions. Firms with good management see that quality embedded in current cash flow measures. They are unlikely to get better. Firms with poor management, by contrast, have substantial room for improve-ment. Given these future prospects, it is bad managements that should command higher multiples, however obtuse that may initially seem. Page 44
Pages 59-63 are very important in laying out how to think about Asset Value and Earnings Power Value and what the relationship between the two means. If EPV is far higher than AV, either the company has a sustainable competitive advantage through 1) privileged access to customers, 2) proprietary technology, or 3) economies of scale or the EPV will be brought down over time by new entrants who can afford to buy all the same assets and create the same business.
More than 80% of active fun managers under perform their market punch mark over a 510 and 15. Ending in June 2018. And not 15. The S&P 529.3% a year; the cheapest Quinn tile of stock sorted by earnings to price Returned 11.8%. Page 10.
Value investors regard price fluctuations as opportunities to buy or sell, not as accurate estimates of the intrinsic worth of the security. Page 14.
The future returns a portfolio is organized by market to book ratios increase steadily with the degree of cheap. The cheapest sells bucket of stocks often see 2/3 of the companies go bankrupt. But the ones that do survive do so well relative to their very low starting prices that the ugliest portfolios are the best performing among all the buckets. Portfolios of ugly, disappointing, obscure and boring stocks repeatedly generated higher returns in both the market has a hole and more strikingly portfolios of attractive, highly profitable well known in glamorous stocks. Page 22.
Overall, the statistical evidence, both for the United States and overseas markets, paints or remarkably consistent picture. Embracing stocks that are ugly, boring, obscure, disappointing in there for cheap has historically been the best way to buy stocks in which you are likely to be on the right side of the trade these are the stocks that I’ve performed the market as a whole. The uglier, more boring, more obscure, more disappointing in therefore usually the cheaper the stock the better the returns have been. Page 25
Greenwald talks about the basic human instinct that most have to get rich quick. He compares investing in glamour stocks to lottery tickets that hold out the promise of spectacularly high returns. Because of the appeal so investors are willing to pay rationally high price relative to their fundamental Values. Page 26.
The issue of size bias is more important and more interesting.
Many funds cannot invest in small companies, either because their mandates do not allow it or, more frequently, because they have too much money to manage and small companies just can't absorb enough of it to make it worthwhile. If a diversified investment company-most mutual funds—with $10 billion to invest wants to own stock in 100 companies, it needs on average to buy $100 million in each. Since the fund does not want and is often not allowed to own more than 10% of any company's stock, this limits the universe of investment choices to firms with market capitalization of $1 billion or more. The specific sizes of funds, the market capitalization of suitable firms, and the percentage of ownership will vary, but the impact of company size persists. Many funds simply cannot buy shares in small companies. For similar reasons, investment analysts within institutions will also concentrate on large capitalization opportunities. An insight into a $40 billion company that can absorb a $2 billion investment will be worth far more than an equivalent insight into a $400 million firm that can absorb only $20 million. The consequence is that coverage of and demand for small company shares will tend, all other things being equal, to be below that of large company shares, and small company stocks should be cheaper. 18 Hence, the shares in small companies are cheaper, all other things being equal, than shares in large companies. Among the "all other things" that need to be held constant, growth prospects are the most important.
Small companies typically have the opportunity to grow faster than large ones, which already control major segments of the markets in industries that are likely to be well developed. Page 31
Other business characteristics may have a more ambiguous impact on multiples. Good managements, for example, should enhance value per unit of cash flow. They will operate more carefully, lowering risk, and allocate retained earnings more effectively, enhancing future returns.
Still, overall future business performance will depend on the quality of management in the future, and how that compares to the people presently in charge. Here careful reasoning produces counterintuitive conclusions. Firms with good management see that quality embedded in current cash flow measures. They are unlikely to get better. Firms with poor management, by contrast, have substantial room for improve-ment. Given these future prospects, it is bad managements that should command higher multiples, however obtuse that may initially seem. Page 44
Pages 59-63 are very important in laying out how to think about Asset Value and Earnings Power Value and what the relationship between the two means. If EPV is far higher than AV, either the company has a sustainable competitive advantage through 1) privileged access to customers, 2) proprietary technology, or 3) economies of scale or the EPV will be brought down over time by new entrants who can afford to buy all the same assets and create the same business.
August 22, 2018
Ben Graham taught value investing with David Dodd at Columbia, starting in 1928. Since then, Columbia has been the academic center for value investing. Graham and his disciples have been extremely successful, mainly because they used Graham’s investment concepts. But as competition improved, Graham’s rules for valuation of stocks needed updating as well. After some years in the shadow of Modern Portfolio Theory, Professor Greenwald brought back value investing teaching to Columbia in 1993. The logic is the same, but the operationalization is adapted to current standards of pricing of assets. His acknowledged course is the starting point of this book.
We all know how to value stocks in theory – it’s all about the net present value of cash flows. We need to do a lot of input - for many years. But few of us excel in forecasting. Slight changes in input variables change the value of the stock significantly. Is there a better way?
I believe Professor Greenwald’s approach is the way to go. It’s based on basic capitalism, supply and demand and barriers to entry. Most companies don’t have a sustainable competitive advantage and should be valued to reproduction cost. Usually reproduction cost is equivalent to earnings power value. Sometimes, with a truly good management team, earnings power value slightly exceeds reproduction cost value. Only for companies with a true competitive advantage – usually economies of scale with either patents or some consumer captivity – are calculations of profitable growth value needed.
These three building blocks – 1) reproduction cost value (replacement cost of net assets), 2) earnings power value (the value of a company’s current earnings, properly adjusted) and 3) profitable growth value (the uncertain contribution of growth to intrinsic value) - are the core of Professor Greenwald’s valuation approach. It is far easier to forecast long-term value drivers for these building blocks than to do a common DCF analysis; moreover, the outcome is easier to understand. How much do I pay for estimated growth? What is an informed industrial buyer prepared to pay for the assets?
The authors will walk you thru all the needed adjustments to calculate the different parts of a company’s intrinsic value. It’s a joyful ride and there are several interesting case studies that help you understand the valuation approach better. You will never return to doing DCFs as your primary valuation approach.
Part three of the book is about value investing in practice, with profiles of eight value gurus such as Seth Klarman, Walter and Edwin Schloss, Mario Gabelli, Glenn Greenberg etc. These pages are interesting as well, but not – surprisingly enough – up to par with Professor Greenwald’s writing about valuation.
I have read many books about security analysis and valuation. Some have been very good but none has helped me as much with practical valuation as Value Investing. The margin of safety to buy this book is enormous. This easy- to-read book is for everyone including very experienced analysts, except for those that focus on earnings surprises.
I have read this book several times, and I believe you will too if you belong to the value investing tribe.
We all know how to value stocks in theory – it’s all about the net present value of cash flows. We need to do a lot of input - for many years. But few of us excel in forecasting. Slight changes in input variables change the value of the stock significantly. Is there a better way?
I believe Professor Greenwald’s approach is the way to go. It’s based on basic capitalism, supply and demand and barriers to entry. Most companies don’t have a sustainable competitive advantage and should be valued to reproduction cost. Usually reproduction cost is equivalent to earnings power value. Sometimes, with a truly good management team, earnings power value slightly exceeds reproduction cost value. Only for companies with a true competitive advantage – usually economies of scale with either patents or some consumer captivity – are calculations of profitable growth value needed.
These three building blocks – 1) reproduction cost value (replacement cost of net assets), 2) earnings power value (the value of a company’s current earnings, properly adjusted) and 3) profitable growth value (the uncertain contribution of growth to intrinsic value) - are the core of Professor Greenwald’s valuation approach. It is far easier to forecast long-term value drivers for these building blocks than to do a common DCF analysis; moreover, the outcome is easier to understand. How much do I pay for estimated growth? What is an informed industrial buyer prepared to pay for the assets?
The authors will walk you thru all the needed adjustments to calculate the different parts of a company’s intrinsic value. It’s a joyful ride and there are several interesting case studies that help you understand the valuation approach better. You will never return to doing DCFs as your primary valuation approach.
Part three of the book is about value investing in practice, with profiles of eight value gurus such as Seth Klarman, Walter and Edwin Schloss, Mario Gabelli, Glenn Greenberg etc. These pages are interesting as well, but not – surprisingly enough – up to par with Professor Greenwald’s writing about valuation.
I have read many books about security analysis and valuation. Some have been very good but none has helped me as much with practical valuation as Value Investing. The margin of safety to buy this book is enormous. This easy- to-read book is for everyone including very experienced analysts, except for those that focus on earnings surprises.
I have read this book several times, and I believe you will too if you belong to the value investing tribe.
March 27, 2023
A 5 star book is an outstanding book that enthralls from start to end. 'Value Investing' by Greenwald has gone way beyond that - it has significantly disrupted my thinking and brought full circle many of the nice ideas I've had about value AND investing over the years.
Some loose ends that left me wondering was what Greenwald intends to define, by his framework of the 3 sources of value so elegantly defined here, and his ever so convincing rebuttal of the DCF framework. Does he intend to define the framework outlined here as the definitive framework of value (smtg all value guys subconsciously do, even if they don't follow the framework)? Or is the book just a thesis of his, to make his case of his own ideas on value. He very understandably has little regard for the traditional DCF and proposes asset-based and earnings power valuation that allows the analyst to focus on what we know, in the present. But then he profiles Buffett, who famously uses the DCF, albeit with Buffett-style, non-PhD adjustments. So which one is it?
All value academics also like to make a case for value, by backtesting these super mechanical 'value' portfolios based on one or two super crude formulae, but then go into an entire diatribe fleshing out the entire school of value - that of qualitative business analysis and sector expertise. So why can't we just invest as mechanically as the backtests, as quant funds have arguably done? Loose end that Greenwald and other value academics leave unanswered. Btw, Greenwald also sheds light on a whole new meaning on what 'sector expertise' truly means (a term that equity analysts and even IB analysts throw around lightly but have no real respect for) - that of being so ass deep into the sector that the analyst truly knows what reproduction costs are for specialized equipment and fixed assets, and how much cash an orderly wind-down to competitors would fetch.
To emulate Greenwald: As a philosophy, value investing has a moat and franchise value. It has a fortress-like competitive advantage that other flimsy philosophies would find a hard time infiltrating lol. Pretentious mfkers would stick to quant and backtest flashy strategies that don't really exist or last lol.
As a strategy, value investing has a moat and franchise value. Most 'value-focused' mutual fund managers would shit their pants when they imagine taking on the same kind of contrarian risk to their reputation that a value strategy requires by nature. Compound that with relative benchmark performance, and the dumb money out there in money market funds that yank money at troughs and pile in at tops and you find it so incredibly difficult to be a true (professional) value investor.
An outstanding book. As the required textbook for the world-class and renowned Value Investing Program at CBS (even 'Security Analysis' isn't required), it lives up to its hype.
Some loose ends that left me wondering was what Greenwald intends to define, by his framework of the 3 sources of value so elegantly defined here, and his ever so convincing rebuttal of the DCF framework. Does he intend to define the framework outlined here as the definitive framework of value (smtg all value guys subconsciously do, even if they don't follow the framework)? Or is the book just a thesis of his, to make his case of his own ideas on value. He very understandably has little regard for the traditional DCF and proposes asset-based and earnings power valuation that allows the analyst to focus on what we know, in the present. But then he profiles Buffett, who famously uses the DCF, albeit with Buffett-style, non-PhD adjustments. So which one is it?
All value academics also like to make a case for value, by backtesting these super mechanical 'value' portfolios based on one or two super crude formulae, but then go into an entire diatribe fleshing out the entire school of value - that of qualitative business analysis and sector expertise. So why can't we just invest as mechanically as the backtests, as quant funds have arguably done? Loose end that Greenwald and other value academics leave unanswered. Btw, Greenwald also sheds light on a whole new meaning on what 'sector expertise' truly means (a term that equity analysts and even IB analysts throw around lightly but have no real respect for) - that of being so ass deep into the sector that the analyst truly knows what reproduction costs are for specialized equipment and fixed assets, and how much cash an orderly wind-down to competitors would fetch.
To emulate Greenwald: As a philosophy, value investing has a moat and franchise value. It has a fortress-like competitive advantage that other flimsy philosophies would find a hard time infiltrating lol. Pretentious mfkers would stick to quant and backtest flashy strategies that don't really exist or last lol.
As a strategy, value investing has a moat and franchise value. Most 'value-focused' mutual fund managers would shit their pants when they imagine taking on the same kind of contrarian risk to their reputation that a value strategy requires by nature. Compound that with relative benchmark performance, and the dumb money out there in money market funds that yank money at troughs and pile in at tops and you find it so incredibly difficult to be a true (professional) value investor.
An outstanding book. As the required textbook for the world-class and renowned Value Investing Program at CBS (even 'Security Analysis' isn't required), it lives up to its hype.
Read
September 20, 2021- Selecting securities for valuation;
- Estimating their fundamental values;
- Calculating the appropriate margin of safety required for each security;
- Deciding how much of each security to buy, which encompasses the construction of a portfolio and includes a choice about the amount of diversification the investor desires;
- Deciding when to sell securities
One large class of investors who obviously do not qualify are “technical” analysts, or technicians. Technicians avoid fundamental analysis of any kind. They pay no attention to a company's line of business, its balance sheet or income statement, the nature of its product markets, or anything else that might concern a fundamental investor of any stripe. They care nothing for economic value. Instead they focus on trading data, that is, the price movements and volume figures for any security. They believe that the history of these movements, reflecting the supply and demand for that security over time, traces patterns that they can analyze to infer future price movement. They construct charts to represent this information, and they scrutinize them for signs that will predict how prices will move next and thus allow them to make a profitable trade. For example, momentum investors extrapolate the current price trend, buying securities whose prices are rising in the expectation that they will continue to go up. Sometimes they compare the day's price for the security to a trend line made up of a moving average of the last 30, 90, 200, or some other number of days' prices. Crossing that trend line, up or down, can indicate a change in direction. Surely they intend to buy low and sell high, but low and high here refer to the previous and future prices of the security, unconnected to its fundamental value. For technical investors, Mr. Market is the only game in town. It is also a game that lends itself to trading—buying and selling over a short term. Very few traders ignore technical information. Today's chartists are much more likely to use sophisticated computerized algorithms to detect patterns, and to search for those patterns among different security prices rather than focus on the price history of a single security. But like most technicians, they are at best marginally interested in the fundamental economic value of the businesses underlying the securities.
- Estimating their fundamental values;
- Calculating the appropriate margin of safety required for each security;
- Deciding how much of each security to buy, which encompasses the construction of a portfolio and includes a choice about the amount of diversification the investor desires;
- Deciding when to sell securities
One large class of investors who obviously do not qualify are “technical” analysts, or technicians. Technicians avoid fundamental analysis of any kind. They pay no attention to a company's line of business, its balance sheet or income statement, the nature of its product markets, or anything else that might concern a fundamental investor of any stripe. They care nothing for economic value. Instead they focus on trading data, that is, the price movements and volume figures for any security. They believe that the history of these movements, reflecting the supply and demand for that security over time, traces patterns that they can analyze to infer future price movement. They construct charts to represent this information, and they scrutinize them for signs that will predict how prices will move next and thus allow them to make a profitable trade. For example, momentum investors extrapolate the current price trend, buying securities whose prices are rising in the expectation that they will continue to go up. Sometimes they compare the day's price for the security to a trend line made up of a moving average of the last 30, 90, 200, or some other number of days' prices. Crossing that trend line, up or down, can indicate a change in direction. Surely they intend to buy low and sell high, but low and high here refer to the previous and future prices of the security, unconnected to its fundamental value. For technical investors, Mr. Market is the only game in town. It is also a game that lends itself to trading—buying and selling over a short term. Very few traders ignore technical information. Today's chartists are much more likely to use sophisticated computerized algorithms to detect patterns, and to search for those patterns among different security prices rather than focus on the price history of a single security. But like most technicians, they are at best marginally interested in the fundamental economic value of the businesses underlying the securities.
May 10, 2019
Another great book on value investing - the key to which, I believe is: “Opportunities lie in the gap between value and price.” Different value investors have different ideas about value, but they are always in search of good value.
The book has one of the best ratios of insightful + salient information per page. B/c of that it took a little longer than I had anticipated to read (had to take a lot of notes!). First half of the book went through the tenets of value investing, how it has evolved, how value investing could capture growth (with a great chapter on Intel) and how value investors manage a portfolio. The second half profiles a few great value investors from various parts of the spectrum - Klarman, Schloss's, and Heilbrunn on the classic end of the spectrum (meaning most similar to Graham and Dodd), Gabelli and Price as mixtures, and Buffet and Greenberg as contemporary (combining value with a fisher approach).
The best part of this book was definitely its discussion on franchise value and EPV. Only within a franchise is growth worth anything. “Without any competitive advantage, a company’s earnings are equal to its cost of capital multiplied by its operating assets. We will call this amount free-entry earnings, indicating no special advantage. If it does enjoy a franchise, then the earnings attributable to that franchise are the actual EPV we calculated minus the free entry earnings.”
2 or 3 boring chapters, but mostly great. I recommend to anyone who liked the Intelligent Investor but wanted to learn more.
The book has one of the best ratios of insightful + salient information per page. B/c of that it took a little longer than I had anticipated to read (had to take a lot of notes!). First half of the book went through the tenets of value investing, how it has evolved, how value investing could capture growth (with a great chapter on Intel) and how value investors manage a portfolio. The second half profiles a few great value investors from various parts of the spectrum - Klarman, Schloss's, and Heilbrunn on the classic end of the spectrum (meaning most similar to Graham and Dodd), Gabelli and Price as mixtures, and Buffet and Greenberg as contemporary (combining value with a fisher approach).
The best part of this book was definitely its discussion on franchise value and EPV. Only within a franchise is growth worth anything. “Without any competitive advantage, a company’s earnings are equal to its cost of capital multiplied by its operating assets. We will call this amount free-entry earnings, indicating no special advantage. If it does enjoy a franchise, then the earnings attributable to that franchise are the actual EPV we calculated minus the free entry earnings.”
2 or 3 boring chapters, but mostly great. I recommend to anyone who liked the Intelligent Investor but wanted to learn more.
May 12, 2020
Value Investing
From Graham to Buffet and many more successful personalities. This book teaches you 'the better way' towards sustainable investment of individual stocks.
This book shows various strategies from value investors containing diverse implementations, each investor has a set a rules in alignment with their investing style.
The principles of value investing created by Ben Graham is a complementary to "The Intelligent Investor", offering a more pragmatic viewpoint and some practical techniques that includes calculation.
However a "One size fits all" strategy doesn't exist, principles are shared and respected between value investors.
Hereafter are some of them:
- Independent decisions (don't be fooled by Mr. Market)
- Take a hard but realistic look over the company you plan to invest in
- Leave your ego and assumptions at home
- Don't be (too) greedy, be realistic
- Do not try to time the market
- Make your own calculations
- Spread the risk over intelligent diversification
Anyone who want to start investing into stocks for their future should get the hand on "The Intelligent Investor" at first. If you don't want to spend quality time researching, you should probably invest into ETFs instead.
I appreciated The Value Investors side of this book proving the flexibility of different techniques used to limit risk and enhances a independent financial future.
From Graham to Buffet and many more successful personalities. This book teaches you 'the better way' towards sustainable investment of individual stocks.
This book shows various strategies from value investors containing diverse implementations, each investor has a set a rules in alignment with their investing style.
The principles of value investing created by Ben Graham is a complementary to "The Intelligent Investor", offering a more pragmatic viewpoint and some practical techniques that includes calculation.
However a "One size fits all" strategy doesn't exist, principles are shared and respected between value investors.
Hereafter are some of them:
- Independent decisions (don't be fooled by Mr. Market)
- Take a hard but realistic look over the company you plan to invest in
- Leave your ego and assumptions at home
- Don't be (too) greedy, be realistic
- Do not try to time the market
- Make your own calculations
- Spread the risk over intelligent diversification
Anyone who want to start investing into stocks for their future should get the hand on "The Intelligent Investor" at first. If you don't want to spend quality time researching, you should probably invest into ETFs instead.
I appreciated The Value Investors side of this book proving the flexibility of different techniques used to limit risk and enhances a independent financial future.
December 24, 2019
I enjoyed Greenwald's Competition Demystified very much, and Value Investing offers another revisit on companies' competitive advantages from the valuation standpoint. It is very worth reading for the first half. Because of Greenwald's value investing approach and of the time of the book (my version was in 2001), the book places a heavy focus on the company's book, lesser on earnings power, and much less on growth.
Reading the book nearly 20 years after it was published, I don't agree nor disagree with the author. There's one time for value, there's another time for growth, and there's time to go fishing. The wheel of time might just turn around like that forever, who knows? But at the end of the day, in a past world of limited capital, when few capital chased a lot of assets, asset price was cheap, and value investing hold its throne. In a present world with a ocean of liquidity and capital, value investing might just be less relevant.
(The second part on known investors is not that good. You can have better sources for Buffett, Klarman etc. elsewhere.)
Disclosure: I long Tesla.
Reading the book nearly 20 years after it was published, I don't agree nor disagree with the author. There's one time for value, there's another time for growth, and there's time to go fishing. The wheel of time might just turn around like that forever, who knows? But at the end of the day, in a past world of limited capital, when few capital chased a lot of assets, asset price was cheap, and value investing hold its throne. In a present world with a ocean of liquidity and capital, value investing might just be less relevant.
(The second part on known investors is not that good. You can have better sources for Buffett, Klarman etc. elsewhere.)
Disclosure: I long Tesla.
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