Horan Stephen M. - Strategic value investing techniques from the worlds leading value investors of all time

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Stephen M. Horan

To Connie and Cayse and my late mentor, Jeff Peterson

Robert R. Johnson

To Heidi and my late parents, Rowena and Russell

Thomas R. Robinson

To Linda and my late father, Clarence E. Robinson

SECTION

ONE

INTRODUCTION

All intelligent investing is value investingacquiring more than you are paying for. You must value the business in order to value the stock.

Charlie Munger

W hat do Benjamin Graham, Warren Buffett, Wally Weitz, and Seth Klarman all have in common? They are all value investors. What is value investing? Like beauty, it is in the eye of the beholder. Some view value investing as purchasing shares of companies that have been beaten down and are out of favorselling at a cheap price relative to other available investments. Others may define value investing in contrast to something elsetypically growth investing. Stock indices are often broken down into value and growth components, and a stock must either be classified under the value category or the growth category, but not both. In practice, however, value investing is not so limiting or narrow.

Value investing may involve any type of security or investment but is most commonly associated with the purchase of shares of stock in a company. Value investment deals with purchasing securities that are reasonably priced given their underlying fundamentals, including growth prospects. Ideally, the shares in the company should be trading at a price that is less than the intrinsic value of the shares and hence be considered a value stock. Being a value investor is no different from seeking value in the purchase of any good or service. We generally prefer to buy things when they are selling at a discount and not when they are selling at a premium.

How does price differ from value? At any point, an assets price is subject to the economic laws of supply and demand. If demand for an asset exceeds the supply of that asset in the short run, then the price of that asset should rise and may exceed the long-term value of that asset. Prices can increase dramatically when seemingly everyone wants to buy an asset (remember the Internet bubble of the late 1990s and the more recent real estate bubble). In both cases, market prices exceeded the long-term intrinsic value of the assets, and when buyers stopped buying, prices fell dramatically (perhaps below intrinsic value in some cases). Similarly, if there is a large supply of an asset but few buyers (low demand) at any point, then the price is likely to fall, perhaps below the long-term intrinsic value. If investors recognize this value and start to buy the asset, demand increases relative to supply, and the price should rise (sometimes above intrinsic value). Value investing can be characterized by the practice of buying companies when their intrinsic value exceeds the current market price and selling companies when the current market price exceeds their intrinsic value. Some view value investing as more extreme (deep value), that is, buying good companies when nearly everyone else is selling and selling them when nearly everyone else is buying. At its core, value investing is indeed contrarian by nature; it does something different from other types of investing. However, value investing can also involve the practice of buying a growth stock that other investors are buying when it can be purchased at a reasonable price relative to its growth prospects. We will discuss this in more detail later in this chapter.