Research & Philosophy

An Introduction to Value Investing

Benjamin Graham – widely recognized as the father of value investing – believed that, in the short term, the markets were a voting machine, with a security’s price reflecting its popularity on any given day. In the long term, however, Graham believed the market was more of a weighing machine, aligning a security’s price with its intrinsic value, or the true worth of the issuing company.

For value investors, this means that a security’s price and its intrinsic value often detach from one another in the short term. Because of the manic-depressive nature of the overall market – where sentiment can shift between sweeping, carefree optimism and overwhelming fear and uncertainty seemingly overnight – security prices tend to fluctuate much more than the true worth of the companies they represent.

This irrationality can materialize on the upside, helping to lift prices to dangerously lofty heights. It can also appear on the downside, helping to drag prices to bargain levels.

Value investors target the latter situation, seeking to purchase out-of-favor securities that are trading at discounts to their intrinsic values, and then holding them until the market recognizes their true worth.

By confidently approaching the short-term vagaries of the market with rational, objective analysis, we aim to identify compelling investment opportunities and deliver competitive long-term results. As Graham put it, the market “... often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors.”

The Importance of the Margin of Safety & a Long Term Perspective

In his investment guidebook The Intelligent Investor, Benjamin Graham challenged himself to “distill the secret of sound investment into three words.” The three words Graham chose were “margin of safety.” What does this phrase mean?

Simply put, the margin of safety represents the difference between the price of a security and its intrinsic value. Value investors believe that the larger this margin, the safer the investment. By identifying and purchasing stocks and bonds trading at what we believe to be substantial discounts to their estimated intrinsic values, we aim to build strategies that can accommodate future uncertainty and demonstrate resilience in market downturns. Some holdings will inevitably encounter a stumbling block, and a margin of safety can provide protection if the going gets tough. When it comes to results, value investors emphasize the accumulation of lasting wealth over the pursuit of potentially fleeting short-term gains. Accordingly, we expect to realize significant rewards as the market recognizes the true worth of our purchases.

We acknowledge that this process often takes time. As a result, we exercise patience and manage our holdings from a long-term perspective. Typically, we expect to hold a security between two to five years.

While the essentials of value investing are simple, the process of appraising value and risk is complex, and a full explanation is impossible in this brief summary. For a thorough understanding of both principles and process, see the third edition of Value Investing Today by Charles Brandes, published in 2003 by McGraw-Hill.

Equity Investment Process

Persistent screening of our investment universe yields hundreds of potentially undervalued companies that deserve a thorough examination. Often, these companies are out-of-favor at the moment, with a stock price that has been depressed by recent bad news. In other cases, a company might belong to an unexciting industry that the investment community has largely ignored.

To gain a comprehensive understanding of each of these businesses, we draw on resources ranging from published financial statements to personal company visits. Remember, our objective is to find and purchase shares of businesses that are selling at what we believe to be significant discounts to their true worth. Accordingly, our analysts develop an initial estimate of each company’s intrinsic value. Then, analysts formally present the most compelling opportunities to our firm’s investment committees. The investment committees include senior managers and other seasoned investment professionals. In a typical meeting, the analyst responsible for a given company submits an extensive valuation report and answers any questions posed by committee members. The members of the committee then work together to agree on what they believe the business is worth, and whether, at the right price, the stock should enter our strategies.

Securities for our fixed income strategies are purchased the same way. We evaluate thousands of bonds, focusing on security and credit analysis. The Fixed Income Investment Committee evaluates the merit of individual issues and determines intrinsic value, margin of safety, and a purchase target. In equity and fixed income strategies, weights for sectors and countries stem from individual security selection – not top-down forecasts.