120 years ago today the man behind value investing, Benjamin Graham, was born. Generations of investors have much to thank him for.
For many of us, the time prior to and after the discovery of Graham's investment philosophy can be compared to orienteering without and with a map and compass.
Although the investment world has changed significantly since that time, the main principles behind Graham's teachings are as relevant today as they were 80 years ago.
Daily liquidity and price setting are in principle positive for investors in the stock market. Rational investors may check market prices every day to decide whether it is a profitable time to buy or sell.
Herd mentality and gut reactions mean, however, that fluctuations in share prices can become a yoke around many investors' necks. When euphoria reigns and stocks are expensive, one is tempted to buy. When fear dominates, and stocks are cheap, one is more inclined to press the sell button.
Graham's advice is to make the most of the market's irrationality. This can be illustrated by imagining you have a business partner by the name of Mr. Market. Every day Mr. Market offers a given price at which to buy your stocks from you or sell you his. Imagine that Mr. Market is a manic depressive when it comes to investments. Some days he is in a fantastic mood and offers his stocks at sky-high prices. On other days he feels terribly depressed and offers a very low price for the stocks.
The best thing about Mr. Market is that he doesn't mind being ignored. You can take advantage of his mood swings. In other words, you should not be influenced by his daily up and downturns, but rather benefit from them; buy low and sell high.
Focus on the companies
"Investing is most intelligent when it is most business like," wrote Graham in his book Intelligent Investor. In a world in which the focus is on immediate price updates and daily fluctuations in the market, it is easy to forget that a stock represents part ownership in a company.
That is why the analysis of a company's assets, earnings, market position and competitive advantage should be the basis of investment decisions. Over time it is the company's earnings that determine the shareholders' returns. That is something that is as relevant today as it was 80 years ago.
Margin of Safety
Last but not least Graham insisted that each investment must have a sufficient margin of safety. The future is, by definition, uncertain. Even for companies that have seemingly done everything right, unforeseen events can suddenly put a spoke in the wheel.
According to Graham the best protection against future uncertainty is to use common sense by buying stocks cheaply enough that the return will be good even if not everything goes to plan. In SKAGEN the purchase of securities at a significant discount to their intrinsic value stands at the heart of our investment philosophy.
Learning from Graham
The stock market has changed significantly since Graham's time. Technological developments and the internet mean that information is only a keystroke away. It has therefore become harder to have an edge when it comes to information gathering. The availability of information varies from market to market and from company to company, however. One can thereby gain an advantage, for example by looking among under-researched and unpopular companies as we do in SKAGEN.
Another success factor has been to look for situations where the high level of complexity means that most people capitulate rather than try to untangle the web. Our investment in the Turkish Yazicilar Holding, with its complex ownership structure is a good example.
What has not changed over all these years is investors' behaviour patterns: Focusing more on the upside than the downside; being carried away by the latest popularity wave to make a quick profit when your neighbour starts earning more on his biotechnology shares than you do on your boring old companies; relying on the argument that this time is different; and not being able to see beyond the next quarter. These patterns of behaviour never change.
In SKAGEN we try to exploit investors' irrational behaviour. Two good examples are the Chinese and Korean car manufacturers Great Wall Motor and Hyundai, that we bought at the peak of the financial crisis. The pricing indicated that the world was about to go under and no one would ever buy a new car. Not for some time anyway.
When we first bought into Great Wall Motor the company was priced at less than the value of its net cash. All the other assets – including the value of future production and sale – were thrown in for free. This was a classic value investment in the spirit of Graham which has subsequently provided fantastic returns.
For those of you who have not read Graham's Intelligent Investor, run to your nearest bookstore. It is one of the world's best investments.
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