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The most successful style of investing...

Sep 30, 2009

…yet very few people practice it."The secret has been out for 50 years, ever since Ben Graham and Dave Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years that I've practiced it." - Warren Buffett, 1984

It has been another 25 years since Warren Buffett said this. But the statement still rings true. He is now even more famous than before. The number of books on him has multiplied and business channels now have divisions that track his activities on a daily basis. While Buffett is the most famous, there are others who are successful value investors in their own right and also receive ample media attention.

But if you looked around to see how professional money managers go about their business, you wouldn't find too much of value investing there. The logical question then is 'Why not?' We believe there are certain behavioral stumbling blocks that explain why there are very few value investors despite all the media coverage the discipline receives.

Knowledge doesn't translate to action
Unfortunately, knowledge doesn't always translate to behavior. It is common knowledge that we should use helmets, buckle up our seat belts, avoid smoking, take medical insurance etc. but we don't strictly follow them. It takes deliberate action on our part for us to form habits, mere knowledge is not enough. If we are not able to always do the right thing in such important matters, it is not surprising that we don't choose the best path when it comes to investing.

One size doesn't fit all
The general tendency of investors is to find that magic formula - a method that applies to all situations. In fact, the one time everyone asks for stock tips is when there is market euphoria. The right answer during such times is - 'don't buy anything'. But that's a difficult answer to digest. On the other hand, when markets are unduly pessimistic, there are value picks everywhere. Value investing often doesn't offer picks when we are most interested. That makes it a hard discipline to follow.

Patience in the internet age?
A few months ago Bharti Airtel had come out with a campaign called the 'impatient ones'. That seems to be an apt description of most investors. The way we have evolved, we are hard wired for short term rewards. Short term thinking comes naturally to us. It takes training and mental conditioning for us to shake off the habit and reorient our investment horizons. Value investing requires long term time horizons because there is no guarantee that out of favour stocks that value investors prefer investing in, will suddenly come back in favour.

Standing out from the crowd is difficult
As explained above, the best value picks come exactly at the time when there is pessimism all around. As Buffett himself said, "The most common cause of low prices is pessimism - some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.' Unfortunately, that means one has to do the exact opposite of what others are doing. Buy when others are desperately selling and vice versa. Since we are hard wired to stick to the crowd, it is inherently difficult for us to do the exact opposite.

To conclude, it is not the lack of intelligence or knowledge because of which there are so few value investors. The answer lies in our behavioral pitfalls. We need to master them in order to practice value investing.

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6 Responses to "The most successful style of investing..."

Dr Ram

Mar 8, 2010

Why there is no mention of any Indian reference with regard to most successful style of investing?

Like (1)

Prakash Basrur

Jan 30, 2010

"No Risk No Money" and "More Risk More Money" are the adages aptly applicable in the "Free Market" economy. ake for example the remuneration for the skills employed in the society , a doctor earns more money ( and respect too ! ) than even a briliant scientist ! Similarly , an aircraft driver ( better be called respectfully a "Commander" ) draws 50/100 times more salary that a "Frontier Mail" train driver ! Why is this anamoly in life ? Because we pay more to the one who takes care of our greater risk rather than "equal pay equal work" ! This "risk reward" is the backbone of the "market economy" and applies to all such situations including the popular "satta bazar" in India , i.e. the share market !
The second aspect is the inherent "gambling attitude" of a human being ! What are the so called "Bulls" & "Bears" of this "Satta Bazaar" ? Both are people who act on their "sentiments" at the spur of the moment rather than the so called "heuristic graphs"(statistic) ( "Technical Analysis" in these days of "Science" !)
Go and stand in the premises of any share broker and you will see the frenzy of buyers and sellers who , at all times , act more on their "feeling" than "figures" !
There are a very few lucky "Warren Buffets" whose such "sentimental" decesions have stood the "test of time" but for every such "Buffet" there are millions of other mortals who have licked the dust over the last 30 years ! Unfortunately , again , it is a human habit only to talk about one successful "Warren Buffet" all the times because he is in the media whereas the "fallen warriors" are unheard of !
This is the way life goes on and on ! Does anyone ever calculate the total amount of money he/she has spent on the purchase of "lottery tickets in one's lifetime as against the amount "won" by him/her ? Never !

Like (1)

Anshuman Damani

Jan 3, 2010

beautiful article .. life is simple ..we make it difficult for ourselves

Like (1)

kirtan raut

Oct 3, 2009

We invest to gain more money on original investment.History tells us Stocks Returns have outperformed every class of investment over long term. So what's important returns or long term i.e. period. To me the word Long Terms makes sense. Nobody can predict the market perfectly for the short term. Everybody will give you levels above this level it should have a target of some amount and below this level another target. To me with a long term view both may be achieved or may not be achieved. When you make a buy in a stock you marry that stock so enjoy the Honeymoon Period, Have children,Help them Grow and Retire with Peace.Apply this principle for a stock you buy to stay with it for a lifetime to enjoy its fruits. In nature when you plant a tree, you do not expect it to bear fruits on day one (for so called intra-day investors) or within months (for so called short-terms investors), you have to nurture the plant i.e. give time for your investment to grow. You may be successful sometimes in intra-day or short-term but not always, but in Long Term you will always be successful because you have given time for the investment to grow and also saved transaction costs,time and money lost(intra day-loss,short term-loss).To beat the market is being GOD which is foolish.Lets us live like human beings being humble before GOD(i.e. Market which is Supreme) and have its blessings. In Myths we read a person fasted for long years and GOD was pleased and granted him boon/wishes.So if you want your wishes/dream to come true stay invested for long term .

Like (1)

Pankaj Vaidya

Oct 3, 2009

I have read the literature you are referring "The Super Investors of Graham and Doodsville" many times over because I find it simply captivating.
And the way you started the article "It has been another 25 years since Warren Buffett said this", is really fantastic. Wow!!!.

I would like to add some of my thoughts to your article as to why value investing is difficult to follow.

It takes a particular temperament to follow value investing and not everyone has that.
Take Indian Cricket's celebrated batting pair of Gavaskar and Shrikant.
Even though Shrikant could seen first hand how Gavaskar avoided unnecessary risks, he simply did not have the temperament like Gavaskar and would swing his bat
now and then, and sometimes take took much risks. Also playing risky shots would bring about instant reward in the form of boundaries and sixers and also the
applause of the crowd.

Secondly, people are more fascinated with glamour rather than substance.
I have heard people even say that revenue does not matter, earnings does not matter, business does not matter !!!; only sentiments matter.
To be a value investor you need a personality which extremely values substance over glamour; for example Buffett, Munger and Graham are known to be poorly dressed.

Thirdly, people take audacious debt in good economic times and during bad times when stocks become cheap, they are face salary cuts and risk of job loss and do
not have money and courage to buy stocks. In that case even if they have the right temperament, they are unable to invest in stocks in such times.

Like (1)

Manoj Priyadarshi

Oct 1, 2009

True to say that surest way to succeed in stock market is to opt value investing. Most of the world's richest investors have been value investor. Despite knowing the truth very few are there to follow the path of value investing. Men and their behaviour are evolving. We experience changes once pattern is established. This behaviorial pattern is reflected in individual's action. Over period of time stock market has seen many trends having emerged. In any of the analysis the individual's style of executing his work is important. I am trying to learn the theories on which stock market works. Technical analysis is also important. However, the basic tenats of patience, research and rightful action is required as in the case of value investing. If one exercises restraint and is not easily swayed by the euphoria the technical analysis may work with change in investment style.

Like (1)
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