The Lioness and the Value Investor

Out of sheer boredom I was flicking the channels on the TV one night and came to rest on the National Geographic channel. I saw a lioness, hidden behind tall yellow grass, crouching low, observing a herd of zebra pass by. She was absolutely still and I wondered why she was letting all those zebras pass by. It looked as though she had a planned strategy. Soon I realized that she was observing, trying to make a choice.

Things like which animal was the fattest, which was the slowest, which was the nearest etc. were probably passing through her mind. Then she slowly raised her body, an indication that the choice had been made. She started moving, then running and the hunt was on. In a few seconds the animal was in her grasp and the announcement "Dinner is served!" rang out in lion-land.

A value investor is much like the lioness described above. Never impulsive, but always alert.

A herd of zebras in the form of company shares is running across his gaze every day in the market. He sits quietly, observing the ticker tape, various thoughts passing through his mind. The future potential for growth, dividend history, soundness of the management, and most important, the price. He observes that the 'price' has fallen well below the 'value' he has set on the share and then when all pieces have fallen in the right slot, he picks up the phone, calls his broker and places an order to 'buy'.

Benjamin Graham, the great American security analyst first coined the term 'intrinsic value' of a share and all 'value investors' essentially follow the technique propounded by him. Warren Buffett, the most well known disciple of Graham has been practicing it for a long time and though in recent years he has deviated from it to some extent, the new edifice is still supported by the same sound principles laid down by Graham many years ago.

According to Graham, every share has a certain intrinsic value, which does not necessarily coincide with the market price. For a short time though, it may coincide when the price is climbing or declining. A value investor buys the share when the market price is lower, much lower, than the intrinsic value and sells it when it is above.

He shows immense patience, patience coming out his faith in his own valuation and also the understanding of the fickle nature of the market. Patience and ability to think differently from the market are the two critical characteristics of a value investor.

The issue, however, is how to arrive at the intrinsic value. Though Graham has given certain valuable suggestions, in practice every value investor follows his own rules and uses skills honed over a number of years in the jungle of security investing. What Graham teaches, in my view, is more of art of investing and less of science. In a beautifully constructed paragraph in his book 'The Intelligent Investor' Graham writes thus:

" Additionally, we hope to implant in the reader a tendency to measure or quantify. For 99 issues out of 100 we could say that at some price they are cheap enough to buy and at some other price they are so dear that they should be sold. The habit of relating what is paid to what is being offered is an invaluable trait in investment. In an article in a women's magazine many years ago we advised the readers to buy their stocks as they bought their groceries, not as they bought their perfume. The really dreadful losses of the past few years (and on many similar occasions before) were realized in those common stock issues where the buyer forgot to ask "How much?""

Visualize a woman on a mission to buy groceries. She, in her mind, not only knows what she wants but she also knows how much money she has in her purse and is well aware of her family's needs. On entering the store she never rushes to the shelf but slowly goes around the store and takes in what is available. She may be wanting to buy a bottle of tomato ketchup but she looks at all the brands available, compares the prices, the size of the bottle, usefulness of the empty bottle, discount available for quantity, the contents like artificial coloring etc and then finally arrives at her decision.

She is like our lioness stalking her prey. If she does not find suitable ketchup she will defer the purchase, same as our lioness who will refrain from attacking a rhino since there are no zebras in sight. When Graham suggests asking the question "How much?" he is really asking us to consider all the things the woman did while buying her bottle of tomato ketchup.

An older woman will get much better deals from the grocery store than a newly married younger one, but it will not be many years before the younger woman learns the skill. Similar is the case with value investor. It is practice and dedication that perfects the skill for him.

For a value investor it is always the future that is of interest, but not divorced from the past. He studies the past performance of the company to see a pattern, which allows him to predict the future with some assurance. He studies the market environment and trends to ascertain for himself the demand for the product and the growth potential.

A value investor will not invest in a company making carbon paper, howsoever low the price of the share, because he knows no one will buy carbon paper in the age of photocopying. He will not buy into a company manufacturing diesel engines if he feels that the company does not possess the technology to conform to the emission laws. Yet if he spots a company making a product which in his view is the product of tomorrow he will immediately start eyeing it as a potential prey.

Value investors show an interesting mix of aggressive and defensive tendencies. They look for a sustained growth and unblemished dividend record. At the same time they have a nose for spotting young companies with products which may come into fashion tomorrow and pick the stock much before it catches the attention of the general public, even if the company has not declared any dividend till date.

Those who bought Infosys shares through the IPO with a conscious understanding, fall into this category. They like sound matured management but can also spot dynamic young adventurous entrepreneurs and invest in their companies. In short they spot an opportunity much earlier than the general public. A value investor is not an impulsive speculative killer but a dedicated hunter with a strategy.

Yet the most important criterion for the value investor is the spread between 'value' and 'price'. He wants the share invariably at a price far lower (Graham calls it the margin of safety) than the one he has assigned to it in his mind. Is it feasible? Surprisingly, it is. There are numerous occasions when the market is in the grip of a mood swing and good shares are being offered at throw away prices. Even in a bull phase some times a particularly good share gets quoted at a ridiculously low price. Some times a value investor may come across a company, which fits all his criteria except that of the price. He then shows enormous patience for the price to come down and sooner or later the market does oblige.

The value investing approach has returned great dividends to those who practiced it faithfully yet we find that the approach keeps getting in and out of fashion. In 1984, in an article written to commemorate the 15th anniversary of the book Security Analysis, written by Ben Graham and Dave Dodd, Warren Buffett wrote as follows:

(Please note that this is the concluding part of the article, mainly about students of Graham who had stuck to the principles taught by their master and established an enviable record over a number of years). Buffett says:

" In conclusion, some of the more commercially minded among you may wonder why I am writing this article. Adding many converts to the value approach will perforce narrow the spreads between price and value. I can only tell you that 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 have practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. "

"The academic world, if any thing, has actually backed away from the teaching of value investing over the last 30 yeas. It is likely to continue that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between 'price' and 'value' in the market place and those who read their Graham and Dodd will continue to prosper."

The zebras will continue to graze on the plains of Africa and the lions will continue to hunt them. In the animal kingdom they know a good thing when they see one. Simple rules, which have served them unfailingly for centuries, will continue to remain in practice. The value investor understands this perfectly and though Buffett may not but some of his other value investors take delight in the fact that the rest of the mob does not. He sticks to his philosophy and continues to prosper.