on value investing

[wheeler]

My poker winnings are now large enough that I need to learn about investing. I've been reading all the posts about value investing by Desertcat and others and I must say you've convinced me that this is the way to go.

But I have a lot of learning to do first. I ordered the recommended books on value investing (The Intelligent Investor, Security Analysis, Valuation: Measuring and Managing the Value of Companies) from the other book thread. What I'm looking for now are

(1) a recommendations of the best writing critical of value investing, perhaps caveats for newcomers, the difficulty of beating an efficient market, etc., and

(2) a general introduction to how the markets work. Assume I know nothing (never had much money before).

I have a physics/comp sci ph.d. so do not be afraid to recommend something technical. Thanks.

I don't know of any books, but this newsletter http://www.prudentspeculator.com/ is devoted to finding cheap stocks. I use it as a screener.

-Ernest

[edtost]

(1) malkiel - a random walk down wall street - I'm not a huge fan, but it's the 'classic' of what you're looking for

(2) bodie, kane, marcus - investments - goes over lots of different market instruments, though a lot of the equity material will probably overlap with what you have already.

[buffett]

A value investing book to add to your list: The Essays of Warren Buffett, compiled by Cunningham.....(or you could just read the BRK shareholder letters).

The Chief Buffett Hater is Victor Niederhoffer, and his blog is Daily Speculations.

[DesertCat]

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The Chief Buffett Hater is Victor Niederhoffer, and his blog is Daily Speculations.

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I thought he went bust?

[LearnedfromTV]

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(1) a recommendations of the best writing critical of value investing, perhaps caveats for newcomers, the difficulty of beating an efficient market, etc.,

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Get ahold of Damodaran's Investment Valuation. Read the whole thing, but for this point specifically, read the section "Generalities about Valuation" in the introduction, and read Chapter 6 on efficient market theory. He gives a fair and well articulated account. Most of the rest of what I've seen in support of EMT is full of circular reasoning.

Generally Damodaran does a good job of demonstrating how hard it is to find ineffiencies and how easy it is misinterpret data.

[DesertCat]

[ QUOTE ]
[ QUOTE ]
The Chief Buffett Hater is Victor Niederhoffer, and his blog is Daily Speculations.

[/ QUOTE ]

I thought he went bust?

[/ QUOTE ]

Interesting article on how people percieve options risk. Also talkes about Niederhoffer going bust (twice?). (http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm)

[DesertCat]

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Generally Damodaran does a good job of demonstrating how hard it is to find ineffiencies and how easy it is misinterpret data.

[/ QUOTE ]

Sounds interesting, I'll have to read it.

There is another flaw in value investing that is pretty commonly known, which is the "value trap".

Say you find a profitable company trading for less than it's net cash value. Say it has $12 per share in cash, and $2 a share in liabilities, and earns ten cents a year. But it trades for $5. So you eagerly buy it, because clearly it's worth at least $10.

Two years later, it has net cash of $10.20. But it's only trading for $5.10, the same discount has remained. You earned less than a money market account.

Often in cases like this, the management for one reason or another, doesn't care about freeing up the innate value of the company. It might be controlled by it's founder who feels safe keeping the cash instead of dividending it. Or the mgmt team just is risk averse. The market hated the company two years ago and still hates it today.

One of the key central theorems of value investing is that you can't predict prices in the short run, and the short run can last for a very long time. Keyne's classic quote "the market can stay irrational longer than you can stay solvent" is apt.

Graham's style of investing lead him into some value traps (not too many, he averaged 17% a year including the great depression). Buffett chafed at this, and broadened his approach (with help from Phil Fisher and Charlie Munger) to avoid value traps.

How do you avoid value traps? Well don't buy companies with static or stagnant valuations, unless there is a catalyst. In the example I just gave, if the founder were to die and the family announced they were going to sell the business and dividend back all the excess cash, suddenly a catalyst has appeared. The hard part is finding stocks that are still cheap when the catalyst has been announced.

Buffett decided it was easier to focus on companies that were growing their net worth. If a company can grow earnings 15%+ a year, it will double earnings in five years. Even if it sells for the same PE ratio, the price will have doubled. In this case, predictable earning power is important, and there are a million factors that lend themselves to figuring out a "good" business from a 'bad".

Ben Graham was fond of developing mechanical formulas for novice investors. Typically they lead to very cheap companies that were often value traps. People who've implemented these formulas don't necessarily beat the market (though graham's aim was as much to keep them out of trouble as beat the market). So much of the criticism I've seen of value investing lies in "value traps" and simplistic formulas that some advisors and funds use.

Neiderhoffer once essentially wrote that everything Graham wrote had been disproved, because a single fund that blindly followed Graham's mechanical formula in the 1960's ended up doing poorly.

[wheeler]

Thanks everyone for the references. This is great.