Benjamin Graham invented Value Investing. In 1934, he and David Dodd published the book Securities Analysis, which is considered the most important book for investors. This book distinguishes between investing and speculating.
In 1949, Ben Graham published The Intelligent Investor in which he describes the important concept of Margin of Safety and introduces Mr. Market. Mr. Market symbolises the inefficient investment market.
Speculation or Investment
There is a real difference in how stock markets are approached. Speculation is used to achieve a profit within the shortest possible time. Luck plays a very large role. Time is less relevant, initially, for Value Investing. Preserving capital is the first goal. This means that Value Investment excludes risks.
Sit back, relax and enjoy the flight
Value Investing is just like taking a plane from Amsterdam to New York. Before selecting a flight, one will do a lot of research to find the right flight (price/quality). You know that the flight will take quite a while. Of course you know the destination/goal and you know that you will reach this destination/achieve this goal. There could be some turbulence along the way.
Emotion/psychology, i.e. Behavioural Finance, plays an important role in investments. A lot of people allow themselves to be misled by the market. One of the founders of Value Investing is Benjamin Graham; he refers to this as Mr. Market. When Mr. Market is in a positive frame of mind, he wants to purchase anything at any price. As soon as Mr. Market is in a negative frame of mind, he wants to sell, regardless of the price. The art of Value Investing is not to allow yourself to be misled by the emotions and excesses of Mr. Market, but to grab the chances created by his behaviour.
When an article is on offer and a significant discount is offered on an article in the supermarket, people tend to purchase a bit more. As soon as this happens on the stock markets, and the share prices plunge, Mr. Market becomes nervous and sells all his shares. But this is the right time to purchase the shares at a discount.
In Value Investments, one seeks companies that are on offer and which can be purchased at the stock exchange at a discount. Companies that are worth a lot more than the current market price.
By investing according to the Value Investing philosophy, one excludes risks. If something is on offer, the chances of something being obtained at yet more discount are significantly smaller, than an expensive item. As Value Investors we want to exclude unnecessary risks.
Why invest in the emerging markets, while there are fantastic purchase candidates in Europe, America and China.
Why invest in technology, a business that is difficult to understand and involves a lot of risk because the company is superseded by a competitor. A while ago everyone used a Nokia, currently most people use an iPhone and in future probably everyone will have a Samsung.
Why invest in companies that involve product liabilities risks, such as bio-pharmaceutical companies. At the moment a medicine is developed and the rate of exchange can go through the roof. However, tomorrow two people die after having taken this medicine, and there are significant claims and nobody wants to use this medicine anymore.
Why invest in companies that are lacking transparency, such as banks and insurance companies.
What do we invest in?
We like to invest in manufacturing companies that make products that will still be in demand in the next five to ten years. For example, a car tyre manufacturer. Regardless of whether cars running on petrol, electricity or hybrid cars are the future, all these need tyres in order to run.
After a first selection of companies has been made, the risks are further reduced. We prefer investing in companies with a solid position in the market and do not depend on the large players. It is also very important not to include companies in the portfolio that have a weak financial position. It is difficult for these companies to survive in hard times. We prefer companies that have no more than 25% in debt capital and are therefore not dependent on (external) financing companies.
As soon as a company has been found that is interesting, all we need to do is wait for Mr. Market. The company is valued on the basis of financial ratios such as the exchange rate/profit ratio and the equity capital/EBIT ratio. As soon as the signs turn green, and the company is undervalued, that is the time to fill our shopping cart.
Latest news: Common mistakes of investors
The uncertainties surrounding Ebola, Isis and the Krim have put investors off this past year. The risk aversion resulted in a money flow from mid-cap companies to large cap companies. As a result the stock exchange has sky rocketed. Investment funds, trackers and pension funds purchase shares for unrealistic prices.
Shares such as Facebook boosted the stock exchange this past year. This means Facebook is currently worth $ 171 billion on the market. More than 20 times the turnover is paid for this company. The last time this happened was in 1998/1999 during the tech bubble when investors were prepared to pay 20 to 40 times the turnover.
Are these exchange rates justified?
A simple comparison can be made between Tesla and BMW.
Tesla sold 23,500 cars in 2013, while BMW sold 1.9 million cars. The sales estimates for 2014 are 35,000 cars for Tesla as opposed to 2 million cars for BMW. This means that the turnover generated by Tesla is $ 2 billion, while the turnover generated by BMW is $ 104 billion. Tesla's profit for accounting purposes is therefore $ 103 million, while BMW has a profit of $ 7.3 billion. Tesla's market value is currently $ 26 billion, while BMW 'only' has a market value of $ 69 billion. Tesla is also spending $ 850 million on Research and Development, while BMW has spent $ 41 billion on R&D in the past 10 years. Currently investors are prepared to pay 14 times the turnover for Tesla, while BMW is available for less than once the turnover.
Long live Value investing!
What goes up, must come down. A sharp rise of the stock exchange market is invariably followed by a dip. That is the moment when investors land on their two feet and will realise that manufacturing companies have a lot more value. Investors who made the mistake in 1998 to purchase shares at 20 to 40 times the turnover of companies such as ABN, ING and Aegon were on the brink of crashing for just a little bit of additional return. These investors have recovered somewhat, but are still at the foot of the mountain. Smart investors who decided to invest in manufacturing companies with a solid financial position look down and see that they have achieved great heights, but can also see that they can continue to look up.