A short history of value investing
Value investing got its start with the publication of Security Analysis by Benjamin Graham and David Dodd in 1934.
In this groundbreaking book, Graham & Dodd make careful distinction between the concepts of investment and speculation. "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative," according to the words of Security Analysis. Safety of principal is best achieved by assessing a company’s “intrinsic value” and buying that company at a “margin of safety”, which is a discount to the current share price.
Value Fundamentals
The fundamental principals of value investing put forth in Security Analysis are still widely accepted by followers of this investing style even today. Several of the concepts have been updated to reflect the importance of intellectual capital, brand and other modern business concepts that were less prevalent in the 1930s.
Graham updated and simplified his original work with the publication of The Intelligent Investor in 1949. Often considered the best book ever published on value investing, The Intelligent Investor has introduced the concept of value to millions of investors around the world.
Templeton and Buffett
Without doubt the two best-known practitioners of the Graham & Dodd value style are Sir John Templeton and Warren Buffett.
Templeton was called "arguably the greatest global stock picker of the century" by Money magazine in 1999. He would invest at times of maximum pessimism and would wait patiently for his return.
For example, in 1939 at the start of WWII, Templeton put roughly $100 of borrowed money in the cheapest companies in Europe, all trading for less than $1 and reaped huge gains four years later, on average. Templeton’s deft touch at stock picking is reflected in the performance of his flagship Growth Fund. A $100,000 investment in 1954 would grow to a staggering $55 million by 1999.
Warren Buffett also made his mark as one of the world’s best value investors, achieving long-term returns in the same league as Templeton over the past half century.
Buffett, incidentally, was Benjamin Graham’s most distinctive student at Columbia business school, the only student to earn an A+ grade.
Depressed Valuations
The opportunity to buy stocks at depressed valuations has been most pronounced on a few brief occasions over the past century. These screaming buys were most remarkable for offering the heights of value at the lows of investor sentiment.
Perhaps the cheapest market was the product of the 1973-74 bear market that saw one-third of the value of the S&P 500 Index disappear.
More recently, the collapse in the technology bubble in the late 1990s led to spectacular value opportunities by the end of 2002. Even companies that had no connection to the technology sector were sold off due to investor fear that saw almost half the value of the S&P/TSX Composite Index eradicated.
Value investors that bought at the point of maximum pessimism were handsomely rewarded only one short year later.
Long-Term Patience
Value investors had to wait patiently for this opportunity, to be sure. Good companies were trading cheaply in the late 1990s given most investors’ preoccupation with the technology boom that eventually went bust.
Growth investors were willing to pay obscene prices for companies that were growing quickly and making enormous profits, perhaps at the expense of value investors at that time. But eventually common sense prevailed.
When these companies failed to deliver on the promise of growth, the market fell like a house of cards. Eventually, patient value investors fared best over the entire period.
