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Getting Started in Value Investing ReviewWhat is value investing? It's the idea of buying a part of a business through public shares at a significant discount to the true value of the business.
If you studied efficient market theory in school, you are probably laughing right now . . . for that theory teaches that no one can buy any stock at a discount to its economic value. But consider that many stocks trade as much as 25 percent above and below their average price in any given year. Surely the value of a business doesn't vary that much in 12 months.
Value investors believe that the market misprices securities about 10-15 percent of the time. If you can buy something for half its value, that should be a good deal. The challenge is to spot those mispriced situations.
Value investing has been around for a long time, but most of the earliest texts are hard for new investors to apply (such as Security Analysis by Graham and Dodd and Benjamin Graham's The Intelligent Investor). I was pleasantly surprised to see that Mr. Mizrahi is well versed in both the original approaches to value investing and the adjustments made since then by legendary investors like Warren Buffett and Charles Munger. Mr. Mizrahi also displays a wonderful talent for making security analysis easy to understand and to apply. In the future when students of mine want to learn the basics of value investing, I will recommend this book.
I do recommend that if you decide to apply this approach that you keep in mind that almost all investors underperform the market averages over long periods of time (five years and more). You'll have to be good at value investing to make it work. If it seems like more effort than it's worth, you can now buy index funds that feature small cap, low P/E multiple stocks . . . the sort that have outperformed the overall market averages in the last several decades. Or you can invest along with value investors who run mutual funds . . . or even buy shares in Berkshire-Hathaway, which Buffett and Munger run.
Is value investing right for you? Yes, if you are determined to outperform the averages and are willing to do the necessary homework and stick with it. I believe that will be less than one percent of the people. After reading this book, you should have a better idea of whether you are a good candidate.
If you do decide you like the approach, you'll need to dig into the resources that Mr. Mizrahi cites to learn more.
Let me give you a few cautions about the book:
1. The valuation method described in Chapter 9 is much simpler than what you should actually use. It's better to use discounted cash flow valuations (which are mentioned but not described). If you want to use the test of a future P/E multiple, Mr. Mizrahi is a little generous in his approach. Many industries regularly have P/E multiples much higher and lower than the averages. Adjusting your targets for future P/E multiples to reflect where lower multiples have been the historic case is a good idea not sufficiently developed here.
2. Mr. Mizrahi is a great proponent of ROE (return on equity) as a measure of good performance. Current accounting rules and the share repurchase practices of many companies combine to make ROE not such a good measure as Mr. Mizrahi suggests. Why? Because equity is artificially low so that any earnings are seen a high return earnings.
3. Mr. Mizrahi appears to overstate the case for value investing being a way to outperform the market averages. Yes, some people do achieve that result, but there are no statistics on what percentage do and what percentage don't. I suspect that many value investors don't beat the averages over five year time periods.
4. Mr. Mizrahi explains the concept of economic moats around businesses that allow them to prosper relative to competitors. You should realize that most businesses are losing their moats pretty rapidly now as they face more global competitors than in the past. Only those who are already prospering in most of the countries in the world can be presumed to have good moats now . . . and those moats may erode in the future.
5. Mr. Mizrahi favors larger capitalization companies (over $10 billion in value) to evaluate for potential purchase. You won't find the best buys in that group. Back testing shows that small capitalization companies usually do better on average.
6. Mr. Mizrahi recommends a definition for free cash flow that overstates actual cash availability. It would be better to add the cost in increased working capital to determine actual free cash flow.
7. A few of the tables Mr. Mizrahi supplies seem to have incorrect headings. Wherever you see the same heading repeated for two columns with different numbers, assume the headings are wrong and ignore those tables.
Nice work, Mr. Mizrahi!
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