Several years ago a friend mine Nancy Zambell wrote a timeless
. The timeless article is an excellent account about the common
sense approach to picking stocks known as value investing.
With the market's state of turbulence, investors are scurrying to
find those hidden gems that are not only trading at bargain prices,
but which also have some hope of surviving - relatively intact -
from the ups and downs of market volatility. That's why an
increasing number are tapping into that old standby that can be
counted on through thick and thin: value investing.
Value investing is simply investing in companies whose shares are
temporarily trading at lower prices than their true worth.
In 1934, Benjamin Graham, with his colleague David Dodd,
co-authored Security Analysis, the primer for value investing. Many
editions later, the book has become the bible of security analysts
nationwide. Graham felt that too many investors were speculators -
buying or selling simply because a stock or the market went up or
down, investing in "hot" stocks, and margin buying - all trends of
the era in which he grew up. He lived through the debacle of the
'29 crash, the bank closings and the utter loss of confidence in
Wall Street. He knew for confidence to be restored, and for
corporate America to obtain the funding needed for expansion,
individual investors would have to be brought back into the fold.
Graham proposed that the foundation of sound investing should not
change with the whims of trends or the winds of time, but should be
altered only as a result of important economic and financial
changes. Such events might include changes in interest rates,
inflation, the trend toward mega-corporations, or significant
bankruptcies - all occurrences which might alter the way a stock is
to be valued - quite a different train of thought than what was
currently espoused by the "professionals". You might imagine how
popular that advice was with the Wall Street crowd!
The father of value investing felt that a good investment should be
a company that was worth considerably more that what its stock was
selling for. He calculated this "value" of a company by estimating
its future earnings as well as taking into account the worth of its
assets - what would be the value of this business to someone
interested in buying it. And although even during Graham's day,
there were always analysts ready to build a mountain out of a
molehill, cranking out scores of ratios to analyze one company,
Graham felt that just a few - the most important - criteria would
do the job.
Graham especially liked to invest in companies whose earnings were
reasonably stable, with good growth prospects. Additionally, he
required that they be conservatively financed, large companies that
paid dividends, and had price-earnings ratios of less than 25. And
he found legions of such companies - many that were selling for
less than their net working capital (current assets - current
liabilities) . But for some reason, the stock market and the market
pros were underestimating, or undervaluing the potential of the
companies' earnings, resulting in an "undervalued" stock price.
Graham's success was legendary. During his most active years - from
1936-1956 - he consistently posted annual returns of 20% plus,
while the S&P 500's performance ran around 14%. And his legend
And while small cap investors are typically not following Graham's
classic value investing definition, we're following in his
footsteps. Because today, if you're a large-cap value investor, you
have a tough row to hoe. You're competing against thousands of
other institutional value investors who are looking at the same
information as you.
So, my solution is to focus on value where very few other people
can find it. In the small cap space, we're typically among the
first people to find undervalued securities - for the simple reason
that these companies are too small for institutional investors to
There's less institutional investment, and there's less coverage as
well. So if you do the nitty-gritty work and find an undervalued
company, you are literally in on the ground floor.
It's Graham-Dodd analysis taken to a grass-roots level.