I still consider myself a newcomer to value investing and am always eager to learn more about it. So when The Little Book of Value Investing came out last month, I decided to take a look.
The Little Book of Value Investing is written by Christopher Browne, of Tweedy, Browne Company, a well-respected, 86-year-old investment firm who counted Benjamin Graham as both a client and mentor several decades ago. As such, Browne is writing this book based on years of experience and hard-earned knowledge.
I think the book can best be described as a nice little reference manual. In it, Browne details both his mindset and philosophy as well as details on the calculations and ratios he uses to evaluate a company or stock. Actually, from what I could tell, all the financial ratios and criteria that Browne uses are identical to those written for the defensive investor in Graham’s The Intelligent Investor. (Here’s a quick summary of Graham’s defensive value investing ratios and criteria.) I would have liked to have seen Browne’s own tweaks to these ratios, if he had any, given that many people believe some of Graham’s criteria are a little out-of-date.
The chapter I found most interesting was entitled “Send Your Stocks to the Mayo Clinic”, in which Browne summarizes the questions he asks before investing in a company. To me, the following questions (taken from the chapter) are great ones because they force investors to consider the company, not just the stock symbol, and really get in the mindset of evaluating what makes a company tick, grow, succeed, all of which which, after all, should be long-term reasons why a company’s stock increases or decreases in value. (I’m only listing the questions, but Browne devotes a few paragraphs to explaining each one.)
1. How easily can the company raise the prices on its products?
2. Can the company sell more units of product without resorting to incentives or giveaways?
3. Can the company increase profits on existing sales?
4. Can the company control its expenses?
5. Can the company raise sales without incurring additional costs (like building a new factory or increasing overhead)?
6. If you’re buying a company at a discount because it’s reported bad earnings, can the company be as profitable as it was before? What caused the drop in profit?
7. Are there unprofitable businesses that can be divested?
8. What’s the prospect for the company’s 5-year growth?
Browne continues the list with additional questions on other factors that are also often cited as reasons to buy or not buy a stock:
9. Are there any true one-time expenses that can be ignored?
10. Is the company comfortable with Wall Street’s estimates?
11. What will the company do with any excess cash it has?
12. What does the company expect its competition to do?
13. What’s the company’s selling value?
14. Does the company plan to buy back stock?
15. What are company insiders doing?
I understand why he asks these other questions, but some of them are harder for individual investors to investigate. The “selling value” of a company would be difficult for the average investor to determine (traditionally, this involves calculating cash flows and taking an industry multiple, and everyone has a different opinion on what that should be). Answers to the other questions listed are also difficult to come by without being able to ask company management directly. For individual investors, the easiest way to find this information would be to listen in or obtain transcripts on a company’s earnings calls. (Luckily, it seems the site Seeking Alpha offers such transcripts for many companies for free, a very nice service!)
Personally, while I do find myself actually asking and trying to answer most of questions listed above, I spend less time on questions 9-15 and more on evaluating the company’s competition and peers using questions 1-8. This helps me learn more about the industry, which parts of an industry a company and its peers are doing business in, why one company is performing better than another, and which, if any, might be a good investment.
As far as a reference manual goes, though, The Little Book of Value Investing would make a nice addition to have nearby while you’re doing your research, handy whether you need to look up how to calculate a particular ratio or to find encouraging words reminding you what the philosophy of value investing is all about. However, I don’t think this book can serve as a substitute for The Intelligent Investor, and anyone who’s truly interested in learning about value investing really must start with the original.
I appreciate Browne’s perspective. Probably the most inspiring chapter to me in The Intelligent Investor was the appendix section written by Warren Buffett. In it, he emphasized that value investing doesn’t mean that everyone copies and applies the same rigid set of rules only to find the same companies to invest in and then gave examples of nine value-oriented funds or investors (Tweedy, Browne among them), all of them successful, and all with very little overlap in their investments.
That gives me hope that the more exposure I get to how successful value investors think, the greater the chance that I can succeed at value investing in my own way someday, too.