From understanding to action part 1: Understanding

First steps in value investing

Last year I offered a course in value investing through our local adult education service. The course never happened because only one person applied, but my applicant became a correspondent and is now on the way to becoming a self-taught value investor. But as she’s discovering, learning is one thing, doing is another.

In lieu of a course, I suggested she read one of my articles in Money Observer (Back to Basics pages 1,2 and 3 [all pdf]) and a series of books listed in increasing order of difficulty and expertise. The first was an introduction to value investing I hadn’t read, but had heard good things about. The rest, I’ve reviewed before. Here’s a list with my correspondent’s verdicts:

1. The Little Book of Value Investing by Christopher Browne. Browne, who died last year, was a partner at Tweedy Browne, a US investment company.

…a really good book as a start into value investing. It was easy to read but brought across the main themes of the topic.

I was also relieved to find some practical instructions as to how different websites can be used to filter any potentially interesting stocks. I was so impressed that I recommended the books to my sisters for reading.

2. Investing against the Tide by Anthony Bolton. Bolton is perhaps Britain’s most successful fund manager, and a value investor.

…[Investing Against The Tide] gave me a better understanding of how the world of fund managers works and also how much work it can involve.

Bolton’s book gets mixed reviews but I think it provides fascinating insight into the mind of a value investor (scroll down this page for my review).

3. Value Investing by James Montier (a sequel to Behavioural Investing by the same author).

…[Value Investing] seems to be very well researched. I am enjoying it, but it can be a tough read at times. It reminds me of the “The Long and the Short of it” by John Kay.

Value Investing is a collection of research notes originally published individually when the author worked for two big investment banks. They were written for professional investors and require a basic knowledge of investment and, perhaps, some experience because they expose the reader to research and statistics that demonstrates value investing works.

Each note is only about six pages long, though, and Montier mixes theory and data with John Maynard Keynes, Sherlock Holmes and rants about the inadequacy of financial theory. I found a chapter a day of Behavioural Investing was the perfect accompaniment to a lunchtime Swedish Meatball Wrap from Pret a Manger. This is what I thought of Value Investing.

I could have recommended the Benjamin Graham classic, The Intelligent Investor, before moving on to his textbook, Security Analysis, a path well trodden by value investors, but I’ve never managed to read either from cover to cover. Graham invented value investing, but his books are long and dated (though recent editions include editorials that put them in a modern context).

My favourite investment book is by Graham though, his ideas and methods shoehorned into shorter speeches and writings and collected by Janet Lowe. It’s The Rediscovered Benjamin Graham (reviewed here). There’s also a link between Christopher Browne, the author of the first book on my list and Graham, according to Browne’s obituary:

Tweedy Browne—originally Tweedy & Co.—was the favorite brokerage firm of Benjamin Graham, the founding father of value investing. Its specialty was dirt-cheap shares of closely held companies that rarely traded on major exchanges; Mr. Browne sometimes likened the firm in those days to a "pawnbroker" or "thrift shop."

My first steps in investing were taken under the tutelage of Peter Lynch’s One Up on Wall Street (reviewed here). Lynch is a Wall Street legend who worked for the same fund manager, Fidelity, as Bolton. He opens his book with perhaps the most motivational sentence in investment:

Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert.

Any of these books, and probably many others, should leave the reader with a good understanding of value investing: That the difference between the market price of a share and our own estimation of its value gives us the opportunity to profit, if we’ve got the courage to buy shares in companies when they’re out of favour.

But supposing you’ve done the reading. What then? Or as my correspondent puts it:

The hardest part of investing for me is to move from analysis into action… While there are a lot of websites that help use key performance indicators to identify interesting companies, it is the more thorough analysis of the company and its industry that seem to require a lot of knowledge, experience and time.

That’s a tough one, but I’ve got some ideas I’ll share next week. Maybe you have too.

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Contrarian joins large-cap bandwagon, almost

David Dreman, another value investing fund manager and author of Contrarian Investment Strategies, agrees that big companies have been left behind by the market. He doesn’t favour the ‘defensive’ corporations fund managers think will prosper whatever happens, he’s after:

…strong but volatile companies in industries like materials, industrial supplies, oil and banking. Remember, many investors are still looking through the rear-view mirror at 2008, remembering how badly these industries were beaten up when the market crashed. As the economy continues to revive they should be among the prime beneficiaries.