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  • Value Investing Is Redundant, And Why You Should Stop Saying It 0 comments
    Jun 16, 2012 1:14 AM | about stocks: BRK.A, RIMA

    For the enterprising reader of Warren Buffett, the following should come to you of no surprise if you follow his annual letters. However, I would like to put it out once again if anyone has missed the memo.

    First of all, the investment management industry is generally predicated on the difference between value and growth investing. However, Warren Buffett said it best about "value investing",

    "...we think the term "value investing" is redundant. What is "investing" if it is not the act of seeking value at least sufficient to justify the amount paid?" (pg. 100, The Essays of Warren Buffett: Lessons for Corporate America (TEOWB)).

    It seems that value and growth are mutually exclusive when we label a stock one or the other. Mr. Buffett goes on, "In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous..." (pg 100 TEOWB).

    Another term that Mr. Buffett avoids is "security analyst" or "equity analyst" and refers to himself as a "business analyst" (pg. 77 TEOWB). While an equity (or stock) analyst sounds more exciting at a cocktail party, a business analyst takes a more holistic view of analyzing a company. Perhaps these subtle differences in thinking can take the average investor to the next level.

    Last but not least, the term value investing is suggestive of value if the stock has low P/B, low P/E, or high dividend yield. Mr. Buffett writes, "...such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value..." (pg. 101 TEOWB). For example, some companies would pander to the investment community by raising their dividends funded by expensive external capital despite negative free cash flow. Thus, high(er) dividends is not evidence of a value proposition.David Einhorn compared this use of capital allocation to a Ponzi scheme when he spoke about Allied Capital (9:10 of the link).

    One stock comes to mind is RIM. Oh RIM. I am a little uncomfortable of hearing RIM labeled as a "value stock", due to its low multiples. Other investors suggests that its low valuations invite takeovers, which would boost its stock price, thereby creating "value" for investors. This is speculation to me. Other problems include negative operating earnings for the quarter ending March 3, negative free cash flow for the twelve trailing months and a questionable product line. One thing it does have going for it is its liquidation value and patents if you have a keen understanding. While this isn't a full blown analysis, I think most would agree that RIM is more speculative than investment worthy, which is a better debate than labeling it value or growth. Also, this article was not intended to be focused on RIM, but an example to illustrate my point.

    The point is, traditional value metrics is in no way a guarantee of "value". The investment community, if I had it my way, should slowly faze out the terms "growth" and "value investing" out of their financial vocabulary and give greater emphasis to discounting free cash flow in determining investment merit. Why? Because these terms conceal speculative securities which can do much harm to the investor. If we must label a stock anything, it should be an investment or speculation, as Benjamin Graham has. To paraphrase Graham, there is nothing wrong with speculation, but one should do it with their eyes wide open, expecting excess returns in the long-run to be unlikely.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Themes: value investing Stocks: BRK.A, RIMA
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