I often hear the term "value investing," too much to the point where I begin asking myself two fundamental questions:

1. What do people really mean when they say that they are value investing?

2. What makes a value investor?

Let's be clear from the start. Ben Graham was an investor. Warren Buffett is an investor. Mason Hawkins is an investor. The term value investing was given to their style simply to define what they do best: finding valuable--companies worth more than their current market price--investments.

In my opinion, the best definition of an investment was given by Ben Graham in Security Analysis:

So there it is. A simple, yet elegant definition of what investing ought to be. If you want to call it value investing, be prepared to explain what that really means. When Charlie Munger remarked "all intelligent investing is value investing," he knew exactly what he was saying. If you say you are a value investor, then without exception, you should be applying the three qualifications that Ben Graham laid down over seventy years ago. Each investment should be made only after a detailed assessment of the facts, a compelling valuation that provides a margin of safety, and a return that is better than other viable options adjusted for risk. I would be willing to wager that at least 75% of so called value investors don't come close to passing the test. You can forget about the majority of mutual funds with the name "Value" in them, as they define their investment operation as low P/E, low P/B stock picking.

Charlie Munger said it best when he remarked:

The number one key to a intelligent investing approach is discipline. Discipline is what prevents you from losing money. Preservation of capital is name of the game. I am glad I got a [relatively] early start in investing my own money, because when I look back at my approach, it wasn't truly the prudent approach outlined by Graham. It worked, but the great thing about this game is that if you stay disciplined you are going to learn a lot over time.

The key to remember is that a value investor does not exist in bull markets. Just about any approach during bull markets will make you money. As Seth Klarman aptly put it "Bull markets have of way making everyone look like a genius." A true value investing based approach is designed for bear markets. A value investor's approach is one that can weather the storm during the bear markets and come out with a minimal loss of capital. A successful investing record should be measured in bear markets alone. Earning 90% in a year when the overall market is up 25% tells me zilch about your abilities as an investor. Just look at how many Internet funds were up over 100% per year during their heyday. Losing 10% when the market has tanked 25% on the other hand shows me that an intelligent and disciplined approach was used in making investment decisions.

As Warren Buffet said

Posted by toughiee on Wednesday, August 08, 2007 at 6:09 PM | Permalink