It can take some time to fine-tune your personal investment strategy so that it works for you consistently. And each investor’s personal strategy and tactics will probably be unique to a certain degree.
But one thing that I reckon tends to tangle people up is the difference between value investing and growth investing. And to kick things off, I’m quoting Charlie Munger – Warren Buffett’s ‘partner’ — who once said that “all sensible investing is value investing.” However, I don’t reckon Munger meant we should all rush out and buy bombed-out shares. Read on and I’ll explain.
The father of value investing
Benjamin Graham – Warren Buffett’s one-time mentor – more-or-less invented value investing in its purest form when he published his books such as The Intelligent Investor, which came out as long ago as 1949.
One of the main concepts put forward by Graham is that we should look for a margin of safety when we buy shares. In other words, he suggested we should look for earnings multiples and other measures that appear to value a firm below its true worth – which would represent the margin of safety. The idea was that if we haven’t over-paid for a firm, we can still survive a lot of things going wrong with the underlying business while we own the shares.
And it really took off. In the 1950s (predominantly), Graham himself and adherents to his teachings, such as Warren Buffett and many others, made a lot of money by piling into cheap shares for a quick buck. Often the bombed-out shares would bounce, and the value investors would sell into the rise.
But it was a risky strategy even back then because ultra-cheap valuations often went hand in hand with troubled businesses, which generally had poor economics. Warren Buffett himself got stuck in one that went all the way to zero while he held it – Berkshire Hathaway. The underlying business went the way of the dodo, and the only way he saved his investment was because he had full control of the company and could use its dwindling cash flow to invest in other businesses and stocks.
Growth at value prices
However, such deep-value investing became so popular that it stopped working and even Benjamin Graham reckoned the strategy was no good anymore by the time the 70s rolled around. I reckon if you find a company these days with an absurdly cheap valuation, it probably deserves it and is best left alone.
Pure value investing might be dead, but the concept of buying good value certainly isn’t. In 1992, for example, Buffett wrote in his annual report to Berkshire Hathaway shareholders that value and growth are “joined at the hip.” Growth, he said, is “always” a component in the calculation of value. And that’s what Munger meant when he said sensible investing is always value investing.
These days, Buffett and Munger look for great, growing businesses with attractive economics, and buy their shares as cheaply as they can. The buying price will probably not be as low as those old deep-value plays Buffett used to make, but they won’t be paying sky-high prices for growth either. I reckon that strategy is worth copying for 2020 and beyond.
