Wiley is trying to turn their hit Little Book that Beats the Market (discussion, Amazon.com) into a series: Little Book Big Profits. The second book in the series, The Little Book of Value Investing, is written by Christopher H. Browne and focused on (what else) value investing.
While Browne obviously has the pedigree and experience to write a book on value investing, the lack of practical examples ruins the potential of the book. The basics of the value investing philosophy are presented well and in a way that is easy to read. However, the author seems more interested in convincing the reader into buying into value-based mutual funds than teaching us how to become value investors on our own. The book would be good for current value investors looking for more arguments against market timing and day trading strategies. Aspiring value investors will have to go elsewhere for instruction, though The Little Book of Value Investing may be a good, light introduction for readers who are completely new to the concept of value investing.
Christopher Browne is a successful value investor; his pedigree and experience are chronicled well in the forward by Roger Lowenstein. Browne’s father, Howard Browne, was a founder of Tweedy, Browne and Reilly. TB&R touts none other than Benjamin Graham and Warren Buffet as past clients. The company has been going strong for over 60 years, with our author now in the Managing Director position.
Browne is a contrarian. Value investors are innately contrarian, buying stocks just as they are hated the most. It’s a philosophy of investing I have a lot of faith in, by which I mean that I don’t have faith in the herd mentality of the typical money manager. Early in the book, Browne points out a common flaw with mutual funds and similar managed investment machines:
But it’s not just everyday, individual investors who fall prey to the herd mentality; it also happens to professional portfolio managers. If they own the same stocks everyone else owns, they are unlikely to be fired if the stocks go down. After all, they won’t look quite so bad compared with their peers… (page 3)
In the early chapters, Browne presents the standard value investing philosophy, which can be summed up pretty well here:
- Search for the “intrinsic value” of a stock, just as you would any other purchase. Buy stocks which are undervalued.
- Try your hardest not to lose money. i.e. have a margin of safety (MOS) on your stock purchases.
- In practice, the above two points lead to investors trying to buy $1 of value for less than $1. I’ve typically heard investors strive to buy $1 of value for $0.50. Browne has a chapter titles “Buy a Buck for 66 Cents”, though he doesn’t explain exactly where the 66 cents figure comes from.
In addition, Browne also suggests some of the following tactics:
- Buy stocks that are under book value, the price of the company if it were to be liquidated.
- Pay attention to what similar companies are fetching in leveraged buy-outs.
- Watch for insider buying. In particular, look for insider buying and activists share holders that may act as a catalyst for an undervalued stock.
- Don’t be scared to “catch a falling knife”:
In the halls of academia, under the eyeshades of researchers, and in the rough-and-tumble world of Wall Street, buying stocks that have fallen in price and yet still offer a margin of safety has resulted in successful investments. Although the public at large and most institutional portfolio managers find it difficult to leave their comfort zone and buy stocks that have fallen, those of us buying cheap inventory realize that the bargains are found in the sales flyers and the new low lists, not in highfliers and $12 per pound Delmonico steaks. (page 69)
Not all of the paragraphs in the book are as whimsical as the one above, the book is generally a light read… and quick at just 179 pages.
In chapters 11 through 14, Browne focuses on how to evaluate potential investments. Browne encourages us to check out balance sheets and earnings reports, but again fails to give concrete examples which may actually be of help to us. Instead he says things like this statement on gross profit margin: “I like for this to be a fairly stable number, but often it is not.” The end result is that a reader may learn where to look on balance sheets and income statements, but they won’t know how to process the data they find.
Investments are complicated, and I’m not looking for a “magic formula” as there was in The Little Book That Beats the Market, but I think readers would benefit from some more specific examples. Give us goals for these numbers and let us know when you might want to break your rules and let a company slide on a specific data point.
Chapter 14, cleverly titled “Send Your Stocks to the Mayo Clinic”, is one of the best in the book. It has a series of 16 questions that you should ask of any investment before pulling the trigger. Each question is followed by a decent elaboration on how the question might play out in practice. My favorite two questions of the bunch are repeated below (emphasis his):
5. If the company does raise sales, how much of it will fall to the bottom line? If sales can be grown at no additional cost, every dollar goes right to bottom line profits. If, however, a company has to hire additional salespeople, build new plants, or add additional shipping costs to gain growth, the increased sales will not all translate into bottom line profit… Often the cost of gaining revenue and market share can actually cause profit margins to fall or even reduce a company’s profits… (page 107)
9. Is the company comfortable with Wall Street earnings estimates? Although I rely very little on the estimates when looking for stocks or estimating their value, I like to know if management is comfortable with the earnings estimates the Street is making. If they feel they are too high or too low, I know that missing the earnings will likely cause the stock price to fall, while exceeding the estimate will often cause the price to move higher. (page 109)
Browne also spends some time talking about the benefits of investing globally. It is much easier now to invest in foreign companies. Online brokers and developments like American Depository Receipts (ADRs), which allow you to purchase stock in a foreign company on a local US exchange, take away a lot of the burden that used to come with investing globally. You still have to do your homework though, and it will be tough. Reports may be in another language, accounting practices will be different, and the lack of SEC regulations can lead to some risky predicaments.
In general though, Browne believes that the struggles of investing in foreign securities are worth the effort. Looking globally will effectively double (or more) the number of potential investments. For value investors with tough requirements, this is great.
It won’t be easy though, and Browne let’s you know this. He tells a couple stories where his firm used some obscure accounting mistakes to make a ton of money by buying into companies that would later update their books to show a rosier picture. In one story, Browne buys shares in Lindt and Sprungli, a Swiss chocolate company. At the time of his purchase L&S had a P/E ratio of 10.7, typical of other European candy companies. However, it turned out that S&L was calculating depreciation and amortization differently than some other companies (like Nestle). I won’t even try to understand all of the accounting behind it, but the end result was that with new calculations the L&S P/E was closer to 7.5.
Browne made a killing on that deal. And it was an interesting read, but it also points out one of the flaws of this book. The average investor will not be able to find such deals. Browne explains the accounting on the deal after the fact, and I still don’t understand it. Maybe myself and other “average” investors don’t have the make-up of a value investor. I don’t think so, but this book may lead you to believe it. To be sure, Browne has some sound advice for choosing a mutual fund manager in a later chapter, roughly outlined here:
- “Does the manager have an investment approach and can explain it to you, or any layperson, in plain English, and has the manager applied it consistently over time?”
- “What does the track record look like? Would you have been satisfied with the returns earned if you had been invested with them in the past?”
- “Whose record is it? Does the manager who produced the returns that you find acceptable, still run the fund?”
- “What do the managers do with their own money? Are they invested in the fund alongside the money you intend to invest?”
In chapter 17, Browne argues against “market timing” strategies (which would include day trading and swing trading, etc). While, I believe that this thing people call value investing can be a great way to make money in the market, I take issue with the assumption that no other investing strategy is worth looking in to.
I’ve always believed that there are many ways to be a successful investor, just as there are many ways to run a successful football team or build a successful website. Browne and others cite Warren Buffet and other super-wealthy individuals as proof of the value investing system. Well, I agree that if you are a multi-millionaire and want to become a billionaire, your investment strategy is going to lean toward the side of value investing. There’s just no way to invest $100 million or more in short term trades. The act of selling your stock is going to erase your gain.
However, that doesn’t mean that day trading, swing trading, or any other short-term focused trading is ineffectual. While value investors are looking to a few trades which will make big moves over a medium to long time frame, other investors are successful making a lot of trades that make smaller moves over a short time frame.
Browne gives some arguments against these strategies, which involve market timing. His main argument is that:
It is simply better to be in the market… between 80 and 90 percent of the investment return on stocks occurs around 2 percent to 7 percent of the time… it strikes me as a daunting task to find a way to reliably predict the 7 percent of the time stocks do well. (page 124)
My favorite statistical citation of the book is this one though (emphasis mine):
According to an American Century Investments study, if you had ridden out all the bumps and grinds of the market from 1990 to 2005 (through the go-go 1990s into the severe sell-off from 2000 to 2002), $10,000 invested would have grown to $51,354. If you had missed the 10 best days over that 15-year period, your return would have dropped to $31, 994. If you had missed the 30 best days -one month out of 180 months- you would have made $15,730. Had you missed the 50 best days you would have come out a net loser, and your $10,000 would now be worth only $9,030.
Like I said, value investors should feel free to use that argument when talking with their day-trading friends, however, the argument is flawed. Investors randomly timing the market would be just as likely to miss the 10 worst days as the 10 best days. I would like to know how much your nest egg would be if you missed the 50 best days and the 50 worst days.
I don’t have stats to back it up, but I would guess that good short-term traders are even more likely to time (and avoid) a big loss than they are a big gain. If you spend any amount of time reading the works of day and swing traders, you’ll find that they are much more concerned about managing their risk (or loss) than they are at trying to predict when a stock is going to move a lot. The strategies I’m familiar with are all about finding “safe” trading setups where there is some support (or resistance in short trades) that will ensure the trade doesn’t lose too much money… with a good chance you’ll make some money. Also, most of the day traders I know have adopted the style because the fact that they don’t hold positions longer than a day helps them avoid price crashes.
Okay, end of value investing vs. short-term trading rant.
Throughout the entire book, Browne does a great job of selling the value investing philosophy. While value investing is not the only way to go about things, I think it is sound advice. Buying things on sale, having a margin of safety, looking overseas for opportunities… all sound advice. I also believe that investors of any style should be sure to understand how other investors are working.
The Little Book of Value Investing is an easy read that touches on all the major points of value investing. Practical examples are lacking, so investors who are interested in getting dirty with the stock market will have to look elsewhere for more instruction.
Rating: 2.5 out of 5 stars
Best Suited For: Established value investors looking for anecdotes or complete newbies looking for a light introduction to value investing.
Buy the Book: The Little Book of Value Investing at Amazon.com