Value Investing: The tale of two shoppers

Value investing is a topic that has been written about extensively over the years.

In fact, Warren Buffett’s mentor, Benjamin Graham, was the founding thinker of this style of investing.

And if you are aware of their history, their results suggest there must be something good about value investing.

The topic itself is too big for one blog post…

shoppingSo I want to outline a comparison of two types of shoppers that you might be able to relate with to gain an appreciation of what value investing means.

The two shoppers are a grocery shopper and a perfume shopper.

Now before I proceed, it is important to note that the literature relating to value investing generally concentrates on stocks only…

The beauty of this strategy however, is that it can be applied to almost anything you purchase, especially property.

So I suggest you incorporate this knowledge in your investing strategy for both stocks and property.

Value Investing: The Basics

As I mentioned above, Warren Buffett and Benjamin Graham built considerable fortunes using value investing, so it is fair to say it has stood the test of time…

And like most things that have survived the test of time, it’s based on good old-fashioned common sense.

Its central theme is ‘to not lose money’.

You don’t have to understand anything complicated – like the latest breakthrough technology or the Kardashian family tree.

You don’t have to predict where the share market or property market or the economy is headed.

Leave that to the dart throwing ‘gurus’ who consistently get it wrong anyway.

The value investing strategy essentially involves looking for good quality, easy to understand businesses or properties, that for one reason or another have a price that has been beaten down by the market.

Warren Buffett explains it like this: “Your goal as an investor should be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher in 5, 10 and 20 years from now…

…and when you see one that qualifies, you should buy a meaningful amount.”

Now I can hear you screaming at me already, “But I’m not Warren Buffett.”

I hear you, I get that.

When I first learned of value investing, that was my exact reaction as well. But I persisted and continued to learn more, and let me tell, it was worth it.

The Grocery Shopper versus the Perfume Shopper

In a famous article written by Warren Buffett called ‘The Superinvestors of Graham-and-Doddsville’, Buffett convincingly argues that the extraordinary returns people have achieved through value investing is anything but pot luck.

Buffett introduces a man named Walter Schloss.

Walter was a man with little education, no computer and no employees, who from 1955 until he retired in 2000 reportedly achieved a 15.5 percent compound return.

If he had started with $10,000 in 1955 he would have turned that into $12,500,000 this year.

So let’s look at how you can apply the principles of value investing.

The Perfume Shopper

The first rule of value investing that Benjamin Graham proclaimed was to select stocks the way you buy groceries… NOT the way you choose perfume.

He described the difference in the two approaches as one being a speculative strategy and the other a more methodical or meticulous strategy.

The speculative approach being the one you need to avoid.

He described it like this…

perfumeIf you pay $80 for a bottle of perfume, you are paying for perceived quality.

You can’t measure it in terms of real value.

You can’t really tell why one type of perfume costs $350 and another – that smells exactly like it – goes for around $150.

If you live for the thrill of taking a chance on a stock with a good story – in the hope it will double or triple your money very quickly – you might be attracted to this exciting, but risky, way of investing.

It takes guts – and you’ve got to have faith in the person you get your stock tips from… or belief the chart patterns and trend indicators can help you spot the stocks on the rise.

But then there is another approach… a better approach

The Grocery Shopper

The methodical approach is investing like a grocery shopper.

It’s not a thrill-a-minute joyride like the speculative approach…

It’s methodical and meticulous.

It relies on a cold, emotionless study of the financial data available for the investment: stock or property.

Things like balance sheets, income statements and cash flows.

It’s for serious wealth creators…

value investingLike a good supermarket shopper, it means you will look at all the stock on the shelf, sum up the prices, compare the quality and work out which gives you the most bang for your buck.

It’s not about buying bargains…

It’s about getting the best quality for the best price.

When you’re thinking about investing, you need to approach every purchase as if it was an item you were about to drop into your supermarket trolley.

You have to make sensible, rational investment decisions based on your knowledge of the real value of what you’re paying for.

How to Apply These Rules

How can you apply value investing to your situation?

Effectively you are looking for investments that can be counted on to keep making money year in year out – the more boring the better.

That’s one of the reasons that Buffett has favoured consumer staple companies like Gillette razors…

A few billion men wake up each morning and need to shave!

Another he likes is Coca-Cola. Strong consistent earnings (although they have been struggling recently in the reduced sugar environment).

Now again I hear you saying that you are not Warren Buffett, and it is true that we can’t all be super value investors.

If it were the case, we would all be on the beach with the Kardashians…

But the principles of value investing can be applied to your situation, you can make value judgements on what to buy with the simple strategies identified here.

Know the difference between price and value…

…never pay more than what something is worth and you will be okay.

If you want to learn more about value investing, the best book I have read is ‘The Intelligent Investor’ by Benjamin Graham, written in 1949 but still the most referenced resource when it comes to value investing.

And let me know your thoughts, how could you use it. I’m keen to hear what you think.

 

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