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The Superinvestors of Graham-And-Doddsville

More than 25 years ago Warren Buffett wrote an article about the investment performance of the disciples of Ben Graham and David Dodd. It is a timeless piece about value investing and having a disciplined investment methodology. 

While the performance of Graham’s disciples was undoubtedly impressive, it did occur over a time when there was argubly a less efficient market with fewer competitors for value. Could Graham’s disciples out-perform so impressively in the 21st century?

The Superinvestors of Graham-And-Doddsville

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Yes they will……over time for sure….in the short run….not as of lately…

It depends on how you measure outperformance. If it is as a risk-adjusted return vs. the risk-adjusted return of the market, it’s hard to see how the outperformance can persist to the same degree with more widely and equally disseminated information, computer screens to catch companies, etc..

There is still a decent argument that value will outperform, but there may be fewer value opportunities available per investment period. Growth seems to do well when there is pervasive technological change (so buggy whip companies look like value plays on many metrics, while autos look overpriced), but value does well when technologies aren’t changing quite so fast.

It is hard to imagine when we will se a change as pervasive as computing and the internet. Biotechnolgoy may change too, but it is hard to see how it will impact virtually every industry and household the way computing and the internet has.

Perhaps new energy sources will do that. If we have something like bioproduced hydrogen or stuff that allows large scale energy production off of the grid, one can imagine that virtually all things will end up being retrofitted.

Possibly genetic modification, wherein we grow things that we used to have to produce mechanically; but that still seems a fair ways off.

You want a quote?  Haven’t I written enough already???

Yep, I believe value investing will always outperform over the long run, except in like random bubbles.

I think its more the ideas and hard work that determine your performance not the investing style you choose. For example, Renaissance Technologies’ Medallion fund has returned around 35% annually for the last 20+ years. Its hard to write off such performances as luck.

The people who have a problem with the notion of value investing outperforming are the ones that mistakenly consider value investing as buying stocks with low P/B. Kind of bizarre.

The post isn’t about whether value will stop outperforming over a simple buy-and-hold index strategy. The question is whether the degree of outperformance will be the same as over the last 40 years now that the structure of markets has changed to include more players, better information dissemination, and computers to analyze and screen for opportunities. It seems likely that - while value investing is likely to continue working - it will be harder to generate the super returns that Buffet and others have produced previously.

Whether value works or not is a separate question. I think most people agree that value investing makes sense if done properly. What seems to be the dividing line is people who are dogmatic about value investing (it is the *only* investing strategy that works), and people who simply see it as one of many strategies that can work.

The interesting question is why is it that value underperforms sometimes. Most value investors seem to attribute it to bubbles and mass insanity. But there may be conditions under which the number of value traps increases dramatically and so a value play becomes harder to distinguish from a value trap. When that happens, value strategies may fail without requiring mass hysteria. That’s what my comment about technological change was about.

You want a quote?  Haven’t I written enough already???

I agree with the comment about technological change. I think that goes hand in hand with the uncertainity surrounding the future. At times certain companies might look like solid value plays but time and technology change the basis of the investment thesis and can result in poor performance. Also, value thesis is based on you recognising value before anyone else. But its still works on the premise that someone will EVENTUALLY see the value the way you do. There are two problems here: First, that people might never agree with you. Second, time and technology might again make the basis of that assumption invalid.

Um, I think a core concept of value investing is being able to distinguish value traps from value investments…..

Ok, so if we define value investing as investing in the stocks that are selling at less than their value and aren’t value traps. It outperforms by definition if you assume that you can spot all value traps and avoid them.

And if you say “well, if the strategy bought a bunch of value traps, then it wasn’t really value investing,” then you’ve defined yourself into winning, rather than invested yourself into winning.

It’s like Mark Twain said. The key is to only buy the stocks that go up, and if they don’t go up, you don’t buy them. People who don’t do that are simply dumb.

I get that you are saying that value investing is more involved than simply buying low P/B or P/E stocks. But what makes something a value trap can change over time.

Even growth investing has certain characteristics in common with value investing. The issue is basically that you don’t want to overpay for growth prospects. It can be harder to evaluate high growth prospects, because there are all the variables involved in traditional value investing, plus the task of estimating growth (both rates and durations).

So if you define value investing simply as “I buy things that are good deals relative to growth and existing business prospects,” then yeah, I guess it will always outperform buy-and-hold the index. If you define value investing performance as something actually investible by most people, like an index of managers who claim to be using a value investing strategy, then I think the answer is definitely more nuanced.

You want a quote?  Haven’t I written enough already???

two things.

value investing is in essence buying businesses (yes, different definitions exists but they’re variatons). will buying businesses be less profitable tommorrow than 20 years ago? only if there is some fundamental shift in culture (i.e. Japan) where earnings on equity are not a target or if regulation somehow strangles the hell out of profits.

I find the whole notion of “risk adjusted” returns to be absurd. complete rubbish and useless for me (but I’m not a risk officer for a fund). one of the measures adopted from economic/finance academia that in my view only good for selling funds and used as a marketing tool. ppl who use this concept fail to distinguish between intrinsic business value and market prices, though linked, do not move in tandem.

there really is no such thing as “value investing” as describe by styles or metrics if you ask me. ppl try to categorize things. she is either a hot chick or not a hot chick. just cause she has big boobies does not make her hot.

to me, look at a stock like a business.

there is successful and unsuccessful investing. that pretty much is the only two categories you need.

a high p/e stock can be a low p/e stock when things are taken into account. but low p/e stocks have more safety because we don’t have to reach too deep into the bag of “hope”.

If risk adjustment is absurd, are you levered up to the heels? That would be the sensible thing to do if you think risk adjustments aren’t relevant. Find one good business and buy as much of it as you possibly can.

You want a quote?  Haven’t I written enough already???

bchadwick wrote:

So if you define value investing simply as “I buy things that are good deals relative to growth and existing business prospects,” then yeah, I guess it will always outperform buy-and-hold the index. If you define value investing performance as something actually investible by most people, like an index of managers who claim to be using a value investing strategy, then I think the answer is definitely more nuanced.

What else is value investing but exactly this? To me, value investing is buying stakes in businesses and significant discount to an estimate of intrinsic value, which is estimated using future prospects of the business. Certainly it’s not possible to identify every value trap, but I think every value investor is looking to evaluate an investment by its future prospects, and a big part of that is to avoid stocks that appear “cheap”.

Personally I think the term “value investing” is sort of trite and redundant, but that’s just me. Growth investing in theory is identical to value investing but with firms that have high growth prospects in the future. In practice though, value investors tend to focus on mature firms due to their predictability, simplifying the valuation process. Other than that there is no difference in methodology.

I think what frank meant to say is that defining risk in terms of beta and std devation is absurd. For a example stock worth 100 selling at 50 with high beta has less risk than the same stock selling at 200 with a low beta. In fact, if the stock dropped to 40 it would be even less risk. Calculations of risk adjusted returns would show the value investor to be performing poorly. In my mind, value investing is also the ability to value risk and take advantage when it is mispriced in the market.

You are mixing up risk and uncertainty. You’re referring to uncertainty, risk is really more about price volatility.

perhaps i don’t understand what risk adjusted means, but I thought it meant returns adjusted for volatility in prices. yes, i do buy a lot when i find a great business….i use zero leverage though….

volatility in prices is what I like….the more the better….as long as my limit orders work, its all classy babes in heels….

huh? Palantir, I am surprised you differentiate between the two and you actually consider price volatility = risk??? to me they are the same thing. That’s my whole point, I don’t consider volatility to be risk. Risk to me is uncertainty around what the future holds and the chance that the value of my investment will be permanently impaired.

Well I don’t disagree with you, but that’s the way the terminology works.

i don’t think bchad is coming back…..we’re very arrogant….

frank, its not about arrogance its about finding what makes the most sense. And disagreement is healthy, its what makes our styles and portfolios different and also makes us revisit our philosophy from time to time. If we wanted to agree we’d all then just ending up owning MSFT and Apple in our portfolio.

i agree, but we’re still arrogant ….bchad is a decent guy who would share his girlfriend with you if it came down to it….

There is no God but Value and Warren is his prophet.

Ben Graham = Old Testament
The teachings of his disciple Warren = New Testament

The legendary deeds of the prophet are recounted in his annual reports, by which we interpret his words.

i want to meet charlie munger……

Uh, no. I would not share my girlfriend.

Swap, maybe, but only if everyone is into it.  ;-)

You want a quote?  Haven’t I written enough already???

Buying a stock as if you’re buying the whole business is the most sensible way to approach stock selection in my humble opinion.

I take it one step further and read 10-qs and 10-ks and pretend the board and top executives are talking to me (their boss) directly. I find that it helps me be a more informed shareholder, like Graham encourages shareholders to be.

We know that there are many more human participants (and even a few computers too) involved in the markets nowadays - however the markets still consist of humans which are prone to emotions.

There are plenty of securities out there that are unloved and offer a substantial risk/reward for those with a value investment inoculation - I would know as I have to worked bloody hard to find them and I love the challenge!!

Those Super Investors most definitely could out perform in today’s markets - the process they followed is timeless

welcome new value ppl……

There are two things about risk-adjustment. The first is to figure out whether all that time hunting and sifting through news, 10ks and qs is actually doing any good. If, after a while, I find that all my value investing effort has the same risk adjusted return as an index fund, then I’ve been completely wasting my time, even if I have higher absolute returns. And anyone who says, “I’m an awesome value investor, look at my higher returns” is just full of it if they aren’t actually generating a higher risk-adjusted return. If there isn’t a higher risk adjusted return, it means that what I should be doing is simply levering up an index fund to whatever my risk tolerance says I can handle. Then, since my investment results will be pretty much the same over the long term, I’m supposed take all the time I had been spending on investment research and use it to bang my wife and buy her some really nice things that will make her happy.

The other thing about risk adjusted returns is that even if value investing does work, your portfolio needs to be scaled to what your tolerance for volatility can handle. You may select stocks well, but unless you can fully see the future, you can still have too much of any one stock in your portfolio. Your hard work in detecting undervalued stuff reduces the risk, yes, and that means that you should have more in your portfolio than the market portfolio, but that doesn’t mean your portfolio should have as much of it as you have available capital. You never want to risk so much that you can’t be around for the next holding period.

I think the dogmatic value investors are probably the ones that think that investing ends with security selection. The portfolio construction part is important too.

You want a quote?  Haven’t I written enough already???

I wonder if a sociopath would make a good investor? The Dexter Fund LLC.

I’ve often felt that the finance community has a much higher proportion of sociopaths of various sorts. Certain kinds of obsessive-compulsive behavior can be really useful on the portfolio management side and certain [lack of] boundary issues can be useful on the sales side. These guys get rewarded and promoted early on, when the costs of the behavior are primarily personal while the benefits accrue to the company. Over time, they build up war chests, and then figure that all that money proves that their behavior is the best possible way to live their lives forward.

You want a quote?  Haven’t I written enough already???