This article on Value Investing was written by Thomas Niel. Thomas is a private investor, a financial blogger and an accountant in Washington DC. Creative Commons photo by Walter Rumsby, edited by Broken Leg Investing.
“The Easy Money Has Come and Gone”
It’s easy to concede this belief when comparing today’s value investing world to that of the past.
The “founding father” of value investing, Benjamin Graham, had minimal competition.
Investors in his day bought stocks on hearsay and limited information. Graham turned over rocks to find the true financials, finding deep value camouflaged by manipulation and irregular reporting.
But what if I told you that value investing today was easier, not harder than in Benjamin Graham’s day? That Graham himself would be jealous of the access and ease to opportunities and information that you as an individual investor have today?
It’s true that you likely not find as many deep value stocks as Graham could nearly 100 years ago. While anomalies such as stocks trading at 25% of net current asset value (NCAV) or 1 or 2 times earnings pop up from time to time, too many eyes are watching even the smallest stocks, making these less common.
Value investing for Graham, Buffett, Schloss, and others may have been like “taking candy from a baby”, but the game of “value investing” was hardly a walk in the park.
Value investing at its infancy had its share of challenges and limitations. Before you think the “easy money” has been made and “you can’t find an edge”, consider the many reasons why value investing is much easier today than in Benjamin Graham’s era:
There Are Now More Efficient Methods to Screen for Deep Value
When Graham was developing his process of fundamental analysis, the “stock screener” was several generations away.
Fundamental information on stocks wasn’t widely available until the 1930s. Even after that, it could only be found in the form of printed “manuals” such as Moody’s.
These printed guides would provide an overview of every public company’s fundamentals and performance — information that we can get for free today online.
Without the aid of computerized screeners, flipping through the Moody’s manual was a full-time job in and of itself. As updated financial results became available, you had to order new manuals.
Today’s value investor can use a computerized screener such as Net Net Hunter to find potential deep value and net net opportunities: listed in database format, you can filter by sector, industry, market cap, and discount to tangible to book value, all at a click of a button!
Finding potential opportunities and finding good buys are not the same thing. It still requires qualitative analysis to separate the winners from the value traps. But compared to Graham’s time, this process has been streamlined.
There Is More Information Available Today for Both Individual and Professional Investors
Graham developed fundamental analysis at a time when official reporting of company financials was in its infancy. Companies prior to the 1930s were not legally required to submit annual or quarterly filings.
Corporate and Wall Street insiders had access to this information, but kept it tightly controlled to maintain an unfair advantage.
Benjamin Graham was hardly a Wall Street insider. He operated on the fringes of the financial markets. But with his livelihood depending on his investing acumen, he had the time and resources to dig deep and capture information not yet absorbed by the markets.
An example of this comes early in Graham’s investing career. As detailed in Jeff Gramm’s book Dear Chairman, public companies in general were not required to provide detailed financials. However, industries regulated by the Interstate Commerce Commission (ICC), such as railroads, had to file detailed financial reports to the agency.
These reports provided financial information to a level of detail we see in today’s SEC filings: income statements, balance sheets, cash flow statements, and lists of major shareholders.
Graham studied these reports to gain an informational edge in the market. Wall Street was aware of this data, but didn’t widely utilize it.
In 1926, Graham discovered an offhand reference to oil pipeline companies being required to file reports. Graham was previously unaware of this fact and realized most of Wall Street was ignorant as well of this potential treasure trove of information.
Graham took a trip to Washington, DC, to get copies of the ICC pipeline company reports. While going through the report for Northern Pipeline, he discovered the company held a portfolio of US Government and railroad bonds worth more than the underlying price of the stock. He would eventually launch one of the first activist investor campaigns to force the company to unlock this underlying value.
Wall Street’s limited and unfair use of financial information came to the forefront in the 1929 crash, when Wall Street insiders cashed out (or went short) before it was too late.
Individual investors were left holding the bag — and jumping out of windows.
As a result of this corrupt and unfair system, Congress passed the Securities Exchange Act of 1934. This act gave birth to the Securities and Exchange Commission (SEC), the agency we depend on today to ensure timely and accurate financial reports on US-listed stocks.
Of course, this does not mean individual and professional investors are on equal footing when it comes to information. The asset management industry has the resources to gain access to information not explicitly stated in 10-Ks and 10-Qs.
This unavoidable advantage should not discourage you! Wall Street insiders may have the edge when it comes to large cap stocks, but that leaves small cap stocks undercovered or outright ignored by institutional investors. This leads to more potential for mispricing and greater opportunities for individual investors to gain an “edge.”
“Sum of the Parts” Valuations Today Can Be Quickly Calculated
When assessing the underlying value of a stock, comparing the company’s current valuation to the “sum of the parts” (the underlying value of its operating businesses, real estate, and other tangible assets) will give you an idea of how undervalued the company is relative to current trading price.
Information was a scarce commodity in Graham’s era. It was a challenge getting reliable financials for one stock — imagine trying to get information on a company’s industry peers for a valuation model!
The challenge of “spreading comps” (comparing a company’s valuation to that of its peers) was a more tedious process than it is today. Not only can you easily find financials today on any public company that trades on a listed exchange, but with the use of Fintech software, you can easily export the data to Excel, allowing you build a model using a template.
Valuation of other assets such as real estate holdings is also much simpler today. Graham did not have access to a commercial real estate listing site such as Loopnet.com, which can give even individual investors a rough estimate of commercial property valuations across all geographic regions and asset classes (office, industrial, retail, etc.).
While the freer flow of information largely led to more accurate stock valuations, in undercovered parts of the market (small caps, international markets), high quality deep value stocks still hide in plain sight.
Buying and Selling Stocks Has Never Been Easier
Individual investors today have a much easier time buying and selling stocks. The days of expensive real-life brokers are in the past, and the rise of computerized trading has made brokerage services a race to the bottom: there are even startups (such as Robin Hood) that offer commission-free trades!
Although Graham worked on Wall Street and had direct access to the trading floor, the process was not instantaneous. Getting orders to floor traders required the use of runners who literally ran down from Wall Street offices to the floor of the exchange.
With securities trading a labor-intensive and time-consuming process for a Wall Street professional, imagine how tough it was for a retail investor living thousands of miles away from New York!
First things first — they had to make orders through a live broker. This live broker needed to make a comfortable living, so the trade commission would be leaps and bounds higher than what we spend today using online brokers such as Interactive Brokers or TD Ameritrade.
Then, the order needed to be sent to New York, in order to be executed on the exchange floor. On the exchange floor, traders executed transactions via open outcry.
Shares traded in fractions of an eighth, making each tick 1/8s of a dollar instead of 0.01. Bid/Ask spreads were also much higher than what we experience today.
With the time lag of your trade going through several channels before hitting the floor, the likelihood of “slippage” was high. While we prefer to invest over a medium-length timeframe (1-2 years) instead of making short-term “trades,” buying for slightly more and selling for slightly less is another hurdle to your long-term success in the markets.
Today’s retail investor has a much easier time executing an order. At the click of a button (and for just a few dollars), a value investor can purchase a particular stock within seconds, with a minimal bid/ask spread and less slippage than seen in the open outcry era.
Today’s Value Investor Has a Global Pool of Opportunities
International value investing was not as common in Graham’s day. It wasn’t until after World War II that investors such as Sir John Templeton brought the opportunity to invest in international equities to American individual investors — and this was an indirect method (mutual funds).
Beyond the resources required at the time to trade international securities, one couldn’t easily find information on foreign stocks. There were also no automated translation services to help English-speaking investors comprehend international financial filings. Unless you were fluent in multiple languages, you were limited to the English-speaking world.
There was also less free flow of capital across the globe — even developed countries had capital controls, foreign investment was not as widely accepted, and the emerging markets we speak of today were just starting to industrialize.
The American stock markets have fewer high-quality deep value and net net listings than in Graham’s glory days. However, the ease of trading in foreign markets has opened the door to a global pool of opportunities. Using trading platforms such as Interactive Brokers, you can invest in the best net net and deep value opportunities from across the world (Canada, UK, Japan, South Korea).
Value Investing Is an Easier Game to “Play” — But Harder to “Win”
The opportunity to pursue a value investing strategy has gotten much easier since Graham’s time. Screening has moved from Moody’s manuals to computerized screens. Financial information can be accessed free online. Relative valuations take just a matter of minutes, and real estate valuations are a few clicks away.
Buying and selling stocks is much simpler as well; whether you are in Manhattan, New York, or Manhattan, Kansas, you can place an order within seconds. The commissions on these trades are minimal, and the bid/ask spread is as low as a penny.
This progress has made the game of value investing much easier to “play”. On the flip side, sophistication and competition among investors has made value investing a harder game to “win.”
This isn’t to say the game of value investing cannot be “beaten.” By pursuing a simple value strategy such as the one we use here at Broken Leg Investing — screening for high quality deep value stocks using time-tested criteria, making asymmetrical wagers, taking advantage of wide diversification — you stand a greater chance of “beating the game” and generating above-average returns over the long run.
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