Larry Page and Sergey Brin are are largely responsible for the fact that most noobwhale investors stumble across value investing early on in their journey. If you Google “best investing books,” The Intelligent Investor is right at the top of the list.
What jumps right off the cover is a quote from Warren Buffett- “By far the best book on investing ever written.” Even when you don’t know the first thing about investing, you know who Warren Buffett is. If Buffett said this, it’s probably worth reading, and just like that, you’re on your way to becoming a value investor.
I was one of these new investors that found the ideas of value investing immediately attractive. It appeals to all of our internal egos that we are rational decision makers. Graham describes investing in simple words that anyone can understand. He teaches us that we’re not just buying and selling pieces of paper, we’re buying parts of a business where the whole idea is to pay less per share than they’re worth.
Graham famously described how an intelligent investor should think about the business of investing:
Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
This book and the foundation of value investing called to me, but it didn’t take long for me to learn that there is an ocean of difference between reading a book and successfully applying its teachings. It’s easy to quote Ben Graham, it’s ridiculously hard to follow his principles.
A cheap stock can be expensive if you think about cost as a function of actually making money. I would buy stocks that appeared to have “value” based on traditional metrics like price-to-earnings and other simple ratios. I even took it a step further and shorted a few stocks that appeared outrageously expensive, like Green Mountain Coffee for example. Spoiler, it didn’t work very well.
The tricky thing about buying stocks for less than they’re worth is that it’s difficult to determine out what they’re actually worth. Mr. Market prices companies every day and he gets it right 99 times out of 100. Stocks that appear cheap get that way because nobody wants them, and when nobody wants them, they go down. Stocks on the 52-week low list often appear attractive based on blunt valuation ratios, but in investing, sometimes you get what you pay for. Junky stocks that appear cheap at first glance often appear expensive once you’ve actually owned them for a year or two. Value investing takes brains, the right temperament, and most importantly patience, which inexperienced investors are unlikely to have.
I’ve learned a lot about how investing works since reading Ben Graham.
A few weeks ago I was listening to Wes Gray on The Meb Faber Show when it dawned on me, I’d be hard pressed to point to two people who have taught me as much about as investing as these guys.
Wes is one of the rare academics that puts his theories into practice, and he doesn’t mess with the data to confirm his priors. He has an infectious personality and I remember saying to Barry after I first met him in 2013. “Holy shit that guy’s awesome.” Wes taught me that value investing, even when practiced at the highest level, is really, really hard. His post Even God Would Get Fired as an Active Investor had a huge influence on my thinking about the markets.
I first met Meb through his writing, like so many others. His famous paper, A Quantitative Approach to Tactical Asset Allocation is the most downloaded paper at the SSRN network. I’ll be the first to admit that I was initially skeptical, but then I started digging into the numbers and running backtests on different asset classes and came to the realization that the best way to approach a complex world is with simple solutions. I don’t care how many computers are trading or how short holding periods get, nothing can change the fact that rising prices attract buyers and falling prices attract sellers. Meb opened my eyes to the fact that simple trend-following rules can be an effective way to prevent ruin.
Wes also reinforced what I learned from Meb, that for most investors, simple is better than complex. He wrote “We find that complexity does not add value and simple models often beat experts.” I remember reading this and it gave me a ton of confidence that I was going down the right path.