With a net worth of over $80 billion, Warren Buffett has already cemented himself into the annals of stock market history. Buffett’s conglomerate Berkshire Hathaway has grown its assets to the hundreds of billions, and currently has major stakes in dozens of large market capitalization companies. However, although Buffett’s success may instill awe in the average retail investor, it is how “The Oracle of Omaha” got to this point that is truly important: value investing. In this article, I will explain what value investing is, how it gained popularity, and why it is a sustainable strategy for the retail investor.
Benjamin Graham, a legendary Wall Street mogul, pioneered the idea of value investing. He mentored Warren Buffett on various concepts of value investing, including diversification and fundamental and technical analysis. Graham wrote the book The Intelligent Investor in 1949, detailing the ideals of value investing, the goals of a successful stock-picker, and how to build true wealth by investing in companies. The Intelligent Investor is the most popular investment book in the world, and has been reprinted in multiple editions for the past 70 years.
I would highly recommend anyone looking for information on how to invest and build wealth to read The Intelligent Investor. It is the Bible of the stock market.
At its core, Buffett’s philosophy prioritizes buying a company when purchasing a stock, rather than following any technical chart or aiming for a quick buy and sell transaction. It is part of the reason Buffett has grown his holdings of The Coca-Cola Co (KO) or Kraft Heinz Co (KHC) to over $10 billion each. Buffett continues to add shares of Apple Inc. (AAPL) because, in the words of Benjamin Graham, the tech giant “promises safety of principal and an adequate return.”
Buffett’s investment strategy mainly plays along buying companies that were once solid – or are still excellent companies – but have been deeply oversold, to the point where their price is unjustifiably low. To this end, Buffett’s purchases would likely be along the lines of having a low P/B ratio, indicating a stock’s price has tumbled, as well as high yields on dividends, indicating that companies respect shareholders and intend on delivering tangible results.
That being said, Buffett would not solely focus on fundamental analysis of stocks. There can be a variety of red flags in companies, such as a low market capitalization, high debt combined with low free cash flows, and an unsustainable management strategy. Although Buffett prioritizes what is called an “intrinsic value” of stocks in its fundamentals, the entire picture must be taken into consideration.
In today’s market, Buffett would likely reference Bank of America Corp (BAC) as a good value pick. With a price-to-book ratio of 1.18, a price down from highs of $53.85, and an excellent management team led by Brian Moynihan, Bank of America would be a trustworthy stock that Buffett would advise to buy and hold for decades to come. That is exactly why BAC is one of Buffett’s top holdings in his portfolio.
As Graham eloquently put it in The Intelligent Investor, “investing is a unique kind of casino—one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favor.” Other stock traders, primarily hedge funds and HFTs (high frequency traders) attempt to trade securities with high volatility, high risk, but potentially high return. They will quickly buy and sell stocks in fractions of a second, to make quick returns. They are not analyzing the value of a company – the management principles, the innovation over the past decade, or the room for growth – but rather technical charts and patterns that a computer can analyze. These types of strategies are anathema to Buffett’s careful, pragmatic philosophy.
Whether you support Buffett’s conservative approach to investing or not, there is something to be learned from value investing. Even if you choose to invest in high volatility ETFs, or trade options with a high IV (implied volatility), the main tenets of value investing such as safety margins and risk limitation should be paid attention to and adapted to risky strategies.
Value investing is an important concept to learn for the retail investor. It is important to realize that in order to build true wealth, it is best to invest in the broader market. One such way is to invest in value stocks, which legends Benjamin Graham and Warren Buffett have been able to prove can deliver excellent returns.