This question is too infrequently discussed. If the “secret” of investing is out, why does the majority behave irrationally in markets? You may define “value investing” however you want, but as Charlie Munger said it, all intelligent investing is value investing. Getting more than what you pay for.
The Value Gene
Unfortunately for the sake of argument, we need to break investors into two categories, growth and value. I say unfortunately, because in the real world, this breakdown is oversimplifying. In this example, “growth” oriented is considered pro-risk behavior, and “value” is risk cautious. According to Cronqvist et al. (2013), nature and nurture may play a role. To summarize the research, those who had a tougher upbringing are more drawn to value. A more worry free background and environment leaned to more pro-risk behavior. You can watch a CNBC clip and article on the study here.
Like most academic research, this paper supplied concrete data to our gut instincts; what we “know” or “have a feeling of knowing already”. Though the validity of anecdotal evidence may be up for debate, I think it’s safe to say that there is a value investing “gene” in some sense. The longer you invest and continuously learn, it’s quite evident that market participants are at the mercy of their own psychology. Therefore, the key to successful investing is to not be at this mercy.
Is Value Investing Learnable?
Technically and theoretically, yes. In practice, maybe. Understanding financial statements does not require sophisticated mathematics. On paper, understanding and valuing a business is a learnable skill (like driving a car). Even evaluating management can be done without meeting them in person, since shareholder letters, interviews and past performance give insight into management behavior and the developing “story” of a company. Proxy statements will show what incentives are in place to drive shareholder value and if they’re set with the long-term in mind.
That’s the theoretical and technical part. In practice, other forces come to play. If you’re hunting with a value mindset, everything looks initially expensive. Share prices seem to have no rhyme or reason… Is this the random walk that you’re witnessing? No, it’s not a random walk. It’s supply and demand. If a stock rises, it means there are more buyers than sellers. If it falls, there are more sellers than buyers. That’s all there is to it. Now, there may be a million reasons why participants behave the way they do, but this is your trump card. You have an enormous advantage if, and only if, you can detach yourself from the market. Think about it. You’ll never know all the reasons for price movements, and you don’t have to. So why give them any thought? What matters is determining if price movements are irrational. But alas, for most people this is much easier said than done.
Intelligent investing is “part art, part science”. The science is easier. It’s the “art” that gets people in trouble.
Our Brains are Not Made for This
Stocks are not just fluctuating numbers on a screen. They represent ownership of a business. But most people do not think this way about stocks. If they did, all companies would be fairly priced all the time. There would be no Enrons and Pets.com would be a gazillion dollar operation. We all know get-rich-quick schemes don’t work, but the lure of something for nothing seems too hard to resist.
Human beings are wired to get the best outcome for the least amount of effort. This is completely normal, and is to be expected. This fundamental human condition is what feeds innovation and drives entrepreneurship. We are ready to pay for that which makes our lives easier or leaves our wallet heavier post-transaction.
The stock market feeds and breeds this human condition. Barriers to entry are almost non-existent. Anyone can open up a brokerage account and buy and sell as they please. There’s always an “expert” to confirm your view on any stock. If what you buy goes up right after buying, you start to think you’re smart and this whole stocks thing is easy. A rising market gives you the same social proof in your head as a group of people patting you on the back for being such an awesome guy. Humility starts to fade, and now you’re quite the “expert” yourself. Perhaps your friends come seeking your advice. How you behave during and after these circumstances determines if you’re cut out to do well in markets over the long-term.
If you know that you just had “dumb luck”, would you admit it? Or would you share the “superior insight” you had (aka. that bias confirming opinion piece you found earlier)? Humility and understanding the boundaries of our knowledge aren’t normal human conditions, since most of us think we’re smarter than we really are.
It Takes Work… But It’s Worth It
If you have no interest in business or markets, but still understand the value of long-term consistent investing, there’s no need to worry. Park your money into a broad market index, and consistently add to this account over long periods of time. Compound interest is your friend, as long as you don’t interrupt it unnecessarily.
To those who want to do above average in markets, there’s no way around it: It takes work.
Temperament, Learning & Passion
For starters, you must to have the temperamental quality, a non-negotiable. Have you read the ancient stoics? Name at least five great investors besides Warren and Charlie. What do these five have in common? What differences? The point is not to discourage, but to show the reality. Becoming great at anything requires studying the greats. And applying the knowledge you gain.
More so than intelligence, you need the will to learn, and passion. You have to love the game, not the money. The satisfaction comes from doing good valuation, having exposed Mr. Market’s mistake and your insight being proven correct. A passion for something cannot be forced. It has to be internal. This one quality links people like virtuoso Yo-Yo Ma, racket swinger Björn Borg, space ranger Elon Musk and jump man Michael Jordan. Without it, we would never have heard of them. Do you think they perhaps studied the greats that came before them?
Some Personal Remarks
When I started my investing journey, it took more than a year before I saw any real success. I wasn’t really loosing money (that came later), but I wasn’t making any either. What I did do (and still do), was continuous learning. I was not discouraged from not seeing results, since I knew I had the right mindset and process. I was willing to look foolish in some peoples eyes for buying “stupid things”. Downtrodden, delicately shitty companies. But hey, at least they weren’t expensive!
The stock market is made to seem more complicated than what it really is. There is a high priesthood working for banks, pension firms and the like who have a vested interest in keeping the masses in the dark. It’s their job to make it seem too difficult for “common folk” to understand. The priesthood most likely know about the true faiths (broad market indexing or value investing), but unfortunately they are incentivized to sin.
For those who choose the path of the value investor, it’s like any pursuit worth going after: There are no shortcuts.
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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