If you have been a value investor for some time I am sure you once had to explain value investing to a novice. Among one of the classic first question is the following:“What happens if the stock never closes its gap to fair valuation and stays cheap forever?”Chances are you would answer “…sure, the stock can stay cheap for a long time, but eventually it will trade at fair value.” In this article, I will reflect on the importance of eventually and try to like this to the Buffett quote “I rather buy a great business at a mediocre price than a mediocre business at a great price”. First, let me define my usage of some termini. A “great business” for me is a business that has the sustainable ability to generate returns on capital that are in excess of its cost of capital. Don’t label a business “great” too easily as some businesses generate great returns for a while but these returns seem to disappear suddenly.   How come? In my experience, a “not-great” business can generate great capital returns when industry capacity is very well utilized or management has been brilliant for a while. This does not mean high returns on capital cause a business to bet great! A “not-great” business – let’s call it a mediocre business – is able to extract returns on capital that approximate their cost of capital, if we consider the company life-cycle and not a momentary view.   I would go as far as to say: all great businesses generate high returns on capital but not all high return businesses are great. In the end, the difference between great and mediocre comes down to whether or not a given business possesses competitive advantages. If it does, they can defend their high capital returns for a long time. If it does not, competition will push capital returns down to the cost of capital. Leaving out “special situations”, you normally confront either one of two situations in value investing:A mediocre business at a great price   or   A great business at a mediocre price   Let me present to you a framework how our initial question - “when does the gap between value and price close” - play into each of the two situations: A mediocre business at a great price A mediocre business is worth its replacement value. In a clear-cut world, the long-term earnings power of a mediocre business equals replacement value times cost of capital. Obviously, we do not live in a clear-cut world but still, the replacement value * cost of capital = earnings power equation seems to work pretty well.   The calculation of replacement value and cost of capital is not the topic of this article (which does not mean they are not important- quite the contrary!), so let’s assume you have a given replacement value of 100 for a mediocre company. The stock trades at 50 so you have the epic situation of value investing right in front of you: “to buy a dollar for fifty cents”.   They pay out 5 as a dividend and reinvest 5 into the business. In the next period, the replacement value is 105, the earnings power is 10,5 and they would pay out 5,25. This really looks great at first sight, but it is of no incremental value for you as an investor! You should be indifferent to whether you or one of your portfolio companies compounds money at the cost of capital.     What you look out for is excess return, i.e. the stock going from 50 to 100. Also, the chance of the stock going from 50 to 100 is a compensation for bearing the company-specific risk.   Ascribing a utility to the price/value differential for a mediocre business fully depends on the time horizon it takes for the gap to close. As we have seen earlier, letting time pass does not really add value to a mediocre business so there is no structural “drift” that pushes down the price/value gap of a mediocre business.   So would I never touch a mediocre business? In fact I would not as long as I have no catalyst that allows me to realize the price/value differential in a timely manner. What would be such a catalyst? This is stuff for another article but let’s name a few: the company is a likely takeover candidate, it pays a huge dividend, it is aggressively repurchasing stock,… all factors that “free-up” value.   If this sounds too esoteric, read next week’s article on catalysts in which I elaborate a little bit on the topic. A great company at a mediocre priceLife is quite different when you own a great business. Unlike the mediocre one, this business yields returns on capital in excess of its cost of capital. Waiting therefore increases the intrinsic value of the business faster than your benchmark requires and letting time pass is actually a good thing.   In these cases, you do not really have to worry about when eventually exactly takes place, as any passage of time just increases your upside. Imagine a slingshot in which the sling is pulled further and further. At some point it’ll snap back and you make money. Actually this image is not 100% correct as most great business never trade at super-low prices.   As their value increases on its own, even a very soft tension in the slingshot might be reason enough to jump on the train and ride along with the great business. Almost ironically, a catalyst can be harmful to the investor of a great business. Imagine being bought out of See’s Candy by Buffett in 1972: nice to get a little takeover premium but wouldn’t it have been nicer to reap the 40-year long harvest of a great business?   This allows us to conclude why Buffett once said “I rather buy a great business at a mediocre price than a mediocre business at a great price”. In case of a great business, time is on your side and you do not have to worry much about when the gap between value and price closes. However, do not leave out a mediocre business if a catalyst shortens the time it takes for the price/value gap to close.  

If you happen to be interested in asset management, chances are that you have heard about the concept of factor returns. It’s actually all about certain variables that have some statistical utility to explain stock returns. Scientists found out about these factors by doing a so-called regression, did a lot of testing and ended up with a list of characteristics that determine stock returns. The well-known factors are P/B-ratio, momentum and size. Taking the latter as an example, ceteris paribus, a stock is expected to perform the better the smaller its market capitalization is. There has been an endless academic debate on whether or not these factor returns are just a compensation for risk or offer investors the chance for seizing a mispricing. More details on the factor debate here   At this point however, I would like to bring to your attention a return factor that might have not caught your attention before: return on invested capital (RoIC). This number puts into context the earnings a business derives from operations with the capital needed to keep up operations. The RoIC number is actually a little more complexe to calculate than return on assets as you only consider the capital that is either equity or an interest-bearing liability. Moreover, you do not consider investment assets like excess cash because this is deemed not necessary to keep up operations. At the end of the day, RoIC is just an expression of the old economic idea to generate the most output with the least input. Generally, RoIC is strongly correlated with the „quality“ of a business model. This is intuitive: the better a business is protected against competitors and the more loyal its customers are, the better the chance that your capital earns a high return. In fact, Bruce Greenwald, in his great book „Competition Demystified“, named high RoICs as a good indicator that a business has a durable competitive advantage. RoIC also found the way into other ground-breaking finance concepts like Stern Steward’s EVA. Using the EVA-methodology, managements can make investment decisions on the basis of prospective RoIC vs. underlying cost of capital. Since its launch, EVA has been implemented in many companies. In the investing world, RoIC has found some more recent prominence with the great popularity of Joel Greenblatt’s Magic Formula. The New York Hedge Fund manager selectes stocks by buying the ones that have the most attractive combination of value and quality. As you can imagine, he uses RoIC as a proxy for quality. The results of the Magic Formula are quite staggering and numerous studies have shown that the Magic Formula in fact works quite well. So would it be a good concept to just buy stocks with high returns on capital or maybe take RoIC into consideration when selecting value stocks? While I do utterly believe that RoIC is of highest importance for the smart investor, there are several caveats I would like to remind you of:   Incremental RoIC matter.   In the world of accounting, the balance sheet value of an asset does not necessarily equate its replacement value (to say the least). Therefore, you might run into a company that still uses a long-depreciated asset to generate earnings. Obviously, this pumps up RoIC and says nothing about incremental RoIC. On the other hand, think about an online plattform that spent lots of money to build an IT-backbone but can now scale this platform so that all additional users present infinite incremental RoIC. To make a long story short: focus on the capital needed to support the very next dollar of earnings. More often than not, this is closely correlated with the total RoIC but sometimes it is not. Don’t get fooled.   Think twice about super-high RoICs.   To some businesses, RoIC just does not really matter. Think advertising agencies or investment banks- all they need are a couple of computers, some flipcharts and some tables (spare the billard table). RoIC is incredibly high at these types of businesses. The problem is: they oftentimes do not really need you, the stockholder, as a provider of capital. They are really people businesses that are just the sum of the professionals working there and should be held as partnerships. Let me make a controversial point: most of these consulting-type businesses do not actually have a value on the institution-level. With all their contacts and expertise, the partners obviously are of great value but the name they operate under hardly has any value. However, when you confront the rare situation to have a capital-light consultancy company with a very substantial reason to operate as an organization, a superb investment chance might be at hand. Moody’s (pre-financial crisis) comes to mind as the company’s consultants need no capital to operate but the regulator still demands the work to be done in the name of Moody‘s and not in the name of the single financial analyst. Other businesses like that are certification companies like Bureau Vertias or SGS. Unfortunately, I tell you no secret here and the market normally assigns an ambitious multiple to these companies.   Incremental RoIC is of limited value without CAPEX opportunities.   Warren Buffett’s investment in See’s Candies was probably one of the best he has ever made. He paid something like eight-times earnings / USD 10 mln for a business that drove home a cumulated 1.650 mln after Buffett bought it. Most of that is due to increase pricing- a great example of how to achieve high incremental RoICs. Nevertheless, Buffett also states that he, unfortunately, cannot invest much more money into See’s, as there are no useful investment opportunities left in the business model. Hence, always when you were lucky enought to buy a business that shows the characteristics descibed in 1. or 2., you were also facing an ever increasing reinvesting risk dragging on your IRR. If you are Warren Buffett this is not really a risk as you can compound also huge amounts of money at high rates (side note: this is, in my opinion, one of the least appreciated facts about Buffett: he kept on warning that his alpha will fade but it did so only very, very slowly and arguably not at all on a risk-adjusted basis!). The best that can happen to you is buying an attractively priced business with high RoICs that can reinvest free cash-flows at high RoICs. If you found a good one that I might not know- please tell me.     Keeping these three aspects in mind, the best is still in front of you. Maybe I am completely off and this is stupid (likely, as I have no idea of central bank policies) but something tells me that if a market completely ignores a EUR 500 bln cash infusion by the ECB, we could be at the eve of inflation. Laugh at me because I get transmission mechanisms wrong; laugh at me because the deflating debt bubble is much more likely to cause deflation- but accept my point that inflation is at least not a remote risk. Studies have shown that stocks can be a (relatively) good investment during inflationary times but the results are still somewhat sobering. How come? A big aspect why stocks perform less than expected during inflationary times is the companies‘ need to reinvest into their businesses- which can get quite expensive when prices for investment goods increase. The answer would be to focus on businesses that do not have to invest much when earnings grow. Stay away from high working capital needs. Stay away from huge factories that have to be replaced.   And what’s the method to find out?   Let incremental RoIC be your guide.      

Why isn’t everybody doing it? This post is all about how to survive a bar conversation as a banker these days.I happen to be a banker and my friends happen to know that I am a banker. As the global media has lately been “occupied” by demonstrations of how bankers know sure ways to make money, I have been entangled in bar conversations around the stock market and techniques how to make money in the stock market. So please let me share with you some content from a typical bar conversation I had as of recently. (Disclaimer: if you expect this post to become a little bit more quantitative and useful, keep on reading- if you actually think this post deals with how to survive a bar conversation as a banker, you might be well-advised to keep on reading here ) So my typical friend would ask me, with a gentle sub-tone of sarcasm: “as you are a banker and you work with the stock market, you can now tell me how to make money.”When I respond “yes, indeed”, my friend would normally not believe me and would ask for evidence. Luckily, it’s easy to show evidence in a blog (I have a harder time in a bar), so look here  , here  , here  , here  or here We basically talk about a phenomenon of structural return patters that can be explained by certain factors. In practice these factors come down to buying cheap instead of expensive stocks (value factor), buying stocks on the rise (momentum factor), avoiding stocks that have recently issued new shares (equity offerings factor) and several others. Let me tackle the most prominent of the factors which is the value factor. You have definitely heart about “value mangers”, i.e. fund managers who are on the constant hunt for cheap stocks. Taking a look at value managers oftentimes reveals very attractive long-term track records as these guys capture a large chunk of the structural return outperformance of the value effect. In fact, buying cheap stocks and avoiding expensive ones will make you money, just take a look here . Now my friend would ask me: “why in the world isn’t everybody doing it?” If you are keen to make money but have no interest at all in my elaborate explanation of “why”, then feel free to scroll down to the “how” section in the very last paragraph of this article. The scientists Fama and French got a great deal of attention for empirically testing the value effect (among other effects) and showing that it in fact yields an outperformance. These guys are both disciples of a breed that believes in markets being efficient everywhere and anytime. In their world, excess return can only be achieved by taking excess risk. As value stocks show excess returns they are more risky. QED, right?Well, both gentlemen define risk as variance of returns (vulgo: the more your return jumps around the more risky it is). Unfortunately for Fama / French, the returns of value stocks actually do not jump around as much as they would if the authors’ assumptions were right. Check Capaul, Rowley and Sharpe (1993) for further reference.My very bar friend might now argue that risk could be something else but variance of returns. I couldn’t agree more, so let’s take a look at what Lakonishok, Shleifer and Vishny tested in 1994. They were not satisfied by Fama and French’s risk concept and hence derived a different idea of risk. They say that if value stocks were more risky than growth stocks (i.e. expensive stocks), we could observe periods in which value stocks underperform growth stocks. Moreover, they regard underperformance of an asset class in times of economic trouble as a good indicator for the embedded risk. In fact, during recessions, investors tend to be more risk averse and get rid of risky assets. So if they get rid of value stocks during recessions- we prove that all outperformance of value stocks is just compensation for taking the recession risk! However, during the 1968 to 1989 timeframe, the authors could not show any relation between value stock underperformance and the occurrence of recessions. Indeed, they found only few instances where value stocks underperformed at all. As my bar friend is not stupid, he argues: “if it is not risk that causes value stocks to perform so well- couldn’t I generate a risk-adjusted outperformance easily?”“Kinda”, according to Lakonishok, Shleifer and Vishny. The argument of the authors is that value effect is strongly related to several behavioral heuristics many investors apply. For example, human beings tend to have a hard time thinking in mean-reversion concepts. An ongoing trend is often extrapolated rather than assumed to revert to a general mean. The authors actually find very cool evidence regarding expected growth rates for stocks. For example, there is evidence that the companies with the lowest expected future growth actually show higher growth ex-ante than companies with the highest expected future growth. So much for analyst expectations!Moreover, the authors argue that positions in growth stocks are easier to maintain for institutional investors as they have a history of strong fundamental performance. After all: who wants to present an ugly duckling to the investment committee? Go Groupon! Go Green Mountain Coffee Roasters! (The latter trading for a mere 4.5x sales- after dropping 65% over the last three months) “Good”, my friend argues, “I am neither an institutional investor nor do I have to extrapolate every trend into the future- can I now safely make money by buying value stocks?” “Wait”, argues Jeremy Grantham of investment firm GMO. In his April 2010 speech at the Graham and Dodd Breakfast he tears apart the value effect and presents to us a very convincing case why value effect is related to a special risk when you look closely enough. Read the piece here , I am not exaggerating when I say it is one of the five best articles I have ever read on value investing. Grantham takes a look at proprietary data and tests the endurance of value effect when the economy goes down a lot. Think Great Depression (post-1929) and Great Recession (post-2007). During these times, value stocks performed much, much worse than growth stocks. Please read his paper, the data is mind-boggling. In other words, the outperformance of value stocks is a compensation for the near-wipeout investors suffer in a value portfolio when very hard times hit. For all of you who are familiar with the risk-management concept of value-at-risk: think about the outperformance phases for value stocks as the 99%-area of the return distribution. Only in 1% of the time, disaster hits and your value portfolio gets impaired. Hence, the excess return of value stocks is somewhat of the discounted expected shortfall value stocks suffer during times of crisis. Adding to his point, Grantham also mentions how well high-quality stocks perform over time. Contrary to what you would expect, stocks with healthy balance sheets, high returns on capital and low earnings swings actually outperform the market. Quality is important, especially in times of deep economic trouble but value stocks rarely possess quality attributes. My friend: “therefore my goal should be to a) buy value stocks to capture the institutional mispricing and b) avoid the large declines during deep recessions. How can I do that?”I then go on to explain concepts that combine value and quality like the Magic Formula of Joel Greenblatt or F-Score by Joseph Piotroski. Both add to the list of value stocks an additional layer that kicks out fundamentally distressed companies. What you end up with is a mixture of cheap and good. “Does this make sense to you?” I ask my friend. While my friend nods and orders another round of beer, check out the empirical results from such a cheap/good strategy here  Jan Mohr    

    52 weeks Price Range. This new factor -together with the other momentum factors (price index 12 months and price index 6 months) -in our Value Screener grid indicates a truth about investing that is difficult to understand: the investor should buy into strength and sell into weakness. The factor measures the proximity of a stock to its 52-week high or 52 week low. The 52 weeks price range is calculated as (current price – 52 week low) / (52 week high – 52 week low). The idea behind using momentum factors with valuation is to find the strongest stocks, or the ones that are going up the most in price.  O'Shaughnessy, in his book “What works on Wall Street”, calculated relative strength by looking at the stocks' returns over the past year. Winners seem to continue to win. Price momentum is the market putting its money where its mouth is. O'Shaughnessy states that the longer the period you consider, the more regression to the mean you can see. There is according to him a regression to the mean after about five years. Stocks that have exhibited five years of strong relative strength are usually on the brink of a turnaround (positive or negative). So results must favor shorter-term relative strength. We also added the Price Index 6 months as a separate screener to combine with other valuation factors. In a paper which we will publish soon, we found that the combination of momentum factors with valuation factors results in powerful screens with high investment value.       Profitable Investing.   Philip Vanstraceele  

Short selling (also known as shorting or going short) is the practice of selling shares that have been borrowed from a broker with the intention of buying these shares back at a later date to return to the broker. In less technical terms: a short-seller is betting on a stock price to go down. [More]

  One of the remains of the Graham-Newman era (except Warren Buffet himself ) is Tweedy, Browne Company LLC. Founded in 1920, Buffets favorites’ stockbroker, was located at 52 Wall Street, in the same building as Ben Graham had once worked. Even Walter Schloss was sub-renting some space in their tiny office and running his partnership from behind a battered desk in a small room. They diversified to arbitrage, workouts, etc., all in tradition of the Graham-Newman days, before becoming an investment company and a professional money manager. It was Tom Knapp who joined Tweedy, Brown in 1958 that brought the Graham philosophy along. The companies credo was and still is basic value investing in the Graham-Newman tradition. It manages over 13billion $ in separate accounts for both private customers and institutions as in different managed funds, all Value based.  Since 1993 their Global Value Fund has outperformed their benchmark (MSCI) and resulted in an annual return before taxes of 10.05% (07/31/2011). Christopher Brown was also the author of “The little book of value-investing” and the paper “What has worked in investing” Both must-reads for the Value oriented investor. Their methods are simple and straightforward and are still used as of today; Under valuated stocks have empirically been proven, low risk, and produced attractive long-term rates of return. Before purchase a stock must have one or more of the following characteristics; Low price in relation to asset value ,although Grahams net nets are hard to find (66% of net current asset value)  Low price to book value (preferably with a low <20% Debt to Equity) Low price in relation to earnings (keep in mind that value and growth should go together!) Low price to cash flow. Stocks with low price to dividend yield. A significant pattern of purchases by one or more insiders (managers and directors) A significant decline in a Stock’s price (reversion to the mean is almost a law of nature) Small market capitalization (because of their higher rate of growth and are more easily acquired by other corporations) In fact, there methods and analysis were funded by different value studies made over the years respectively by; Professors Lakonishok,Vishny and Shleifer (Paper: Contrairian Investment,Extrapolation and Risk). http://research.chicagobooth.edu/economy/research/articles/84.pdf Professors Chan, Lakonishok ( “Value and Growth” ; Financial Analysts journal Feb.2004). http://www.lsvasset.com/pdf/Value-Review.pdf Professor Mario Levis (“Stock Market Anomalies” ; Dividend Yield study) They all are still used in conjunction with each other. In fact the basic idea is simply not paying too much for an investment and in that way create a margin of safety, and thus arrive straight back to Ben Graham.   Luc Allaeys    

First : What is short selling ? Short selling is a way profit from falling prices. You can sells shares you don't actually own on the assumption that the price will fall, with the aim of buying them back later for less. But how can you sell something you don't own ? Simple: You can borrow them for a fee from long term investors such as pension funds, banks and insurers who lend the stocks that they have in portfolio. This helps to boost their own returns. The borrower then sells the borrowed stock, hoping to buy them back on the cheap to return it to the owner. Shorting in most cases is a hedge operation. As the name implies, it is an operation where you go long buying stocks, but where you also "hedge" this with some shorts on other stocks. This way you can protect your portfolio against losses if the markets drop. But is shorting not 'Evil' done by rutheless vilified persons? Because of rumours about critical issues such as the health of French banks and the stability of France's triple A credit rating, the bank stocks dropped massively and the regulators blamed everything on the usual culprit: the short sellers. As a result some European countries (France,Italy, Spain and Belgium) decided to ban short selling on their beloved financial institutions. But did these same regulators not conduct a European stress tests on the same institutions a couple of weeks ago ? The tests were performed on banks in 21 countries to assess their ability to withstand a prolonged recession. Most of the banks under the ban rule passed the tests. The same banks are now protected with this shorting ban! Very odd, would you not say ? What does this say about the quality of this stress tests? My opinion is that these test were a waste of time! Things are getting out of control and the authorities are in panic. In contrary to the populists who see short sellers as rumor mongers and conspirators, they are actually among the most fundamentally driven of all the investors. They are closer to the accounting policy than the authorities. They're specialised in detecting companies that are cooking the books. While companiess often accuse short sellers of lying and conspiracy, it turns out that the accusers are often the guilty party (cfr Owen Lamont, Chicago University). Read David Einhorn's book 'Fooling Some of the People All of the Time' about Allied Capital and Lehman Brothers, and you will understand what I mean. You just don't shoot the messenger. The short sellers are not the problem, the bank's bad debts are the problem. A study by academics at Cass Business School and the University of Naples, on the bans in 30 countries in 2008 and 2009, suggests the prohibition could be counterproductive. "It disrupted liquidity and it worsened price discovery", said Marco Pagano, co-author. So bans are not a good idea as the academic studies show that they don't have no long term effect. UK financials stocks actually increased their average daily decline in the months after the ban in 2008.  For example during the financial cricis of 2008 in Belgium, local governments (cities, regions, federal state) borrowed money to invest in the capital increases of theirs major banks. So they levereged to invest in already leveraged companies. The argument  was that they would actually earn money by the high dividend yield distributed by the banks. But these banks don't distribute dividends anymore now. How stupid can one be? Now they say that it is the fault of speculators and short sellers. The stocks are still valued at prices 3 times the market value in the books of these municipal structures. But according to them this is only a virtual loss, because the price is down due to the short sellers. Warren Buffett once said: "In the short run, the market is a voting machine. In the long run, it's a weighing machine". If the price of the banks has been 2 to 3 times lower than the estimated value since 2008, doesn't this indicate there's something wrong about the value? It's time for serious reform instead of ostrich policy and accusing the wrong parties. Philip Vanstraceele        

Benjamin Franklin first stated that the only two certainties in life are death and taxes. Investors have become so gloomy that their expectation are low. "We are going to hell ! ", "Stockmarket crashes", "Experts are expecting a double dip recession": this is the kind of stuff that we have read and hear , the last few days ,on television and in the newspapers.“   Growth is too slow for easy deleveraging, politcians are at loggerheads, and global imbalances have hardly diminished. If central banks respond with more newly-minted money, they could make markets more volatile, and the next crisis all the more exciting. The Swiss and Japanese central banks both moved to halt the appreciation of their currencies, which have been competing with gold for the role of investor's favoured haven. Prominent investors such as John Paulson and David Einhorn of Greenlight Capital have bought gold as an explicit bet that central banks an governments would fail the value of paper as fiat currencies. But at some point, there will be a time when things will go better. It always does ! None of this means that the much-feared crisis will not arrive, sooner or later.   Of course, it is impossible to time the market and things can go worse. But remember what Benjamin Graham said "Individuals who cannot master their emotions are ill-suited to profit from the investment process.”  The strain on the exhanges amid the high volatility has underlined the extent to which the market is dominated by electronic trading, in particular the use of sophisticated computer algorithms that either react to new data or are programmed to try to anticipate it. That cause sudden, sharp movements in prices. These algorithms are no tranquilizers for Mr Markets moods. Warren Buffet once said:"Be fearful when others are greedy, and be greedy when others are fearful. You can't do well in investing unless you think independently. And the truth is, you are neither right nor wrong because people agree with you. You are right because your facts and reasoning are right."  At MFIE we like to keep things simple: we only do a few trades a month: 2 buys and 2 sells. We invest systematically and Mr Market offers us deals through our valueScreeners tool. Today stockpicking is very important to obtain a decent result. The last 10 years the global stockmarket did not really go up and it will probably will not move up during the next 10 years. The market went up too much during the 1980s and 1990s (due to unrealistic rates of return assumptions) and it will need to adjust itself to reality, but that will take some time. Vitaliy Katsenelson defines this as a sideways market. The market is a a cowardly lion—it displays occasional bursts of bravado but is ultimately overcome by fear. The good news is that there are bright spots. The right stocks will rule in sideways markets. In bull markets, all stocks dominate bonds. During sideways markets, most stocks don't dominate fixed income instruments; only the right stocks do. A disciplined buy-and sell strategy must be used to make money in this low-return envirenment. So you need to hope for the best and prepare for the worst. Interesting these days is to look to the deep value stocks like Graham Net Nets and negative enterprise value companies.  Mr Market is offering these with a huge margin of safety. Philip Vanstraceele

Many studies prove that value investing actually works and performs better than other strategies.The premise is basically simple :there is a difference between price and value. As Warren Buffett said 'Price is what you paid, value is what you get'. But the goal is not to buy at fair value, because that will only generate an average return. Your investments should be purchased with a large margin of safety.  This offers a protection against being wrong. Value investing is the only form of real risk management that I know of. It protects you against permanent loss of capital, the real risk. Not risk as Markowitz,Sharpe and other Efficiënt Markets Zealots define it: the volatility or beta of a stock. Of course someone who is leveraged does not have the luxury to ignore the volatility of an asset. But value investing is long term, mostly unleveraged investing ! As Warren Buffett said : "As far as you are concerned, the stock market does not exist. Ignore it! " So with less risk, you get more return with value investing? Gee, that's great ? But if it is that simple, why isn't everyone using it? Value investing requires a contrarian investing attitude, but it is not easy to go against the tide ! Our emotions and behavoir are under the  continuous influences of the media (tv,internet,facebook,etc) and other people. Friends who know me well, can tell that I watch very little TV. For instance, I never watch the CNBC financial news. Their typical "breaking news" flashes makes me crazy. These flashes are just as if the world could stop spinning any moment.   So rather than worry over the last analist's opinion or the next market crisis (a world without crises just isn’t possible, you know), a value investors needs to look to the facts, namely the financial statements and value of a company. Just like House, the a-typical US doctor( one of the few series I like to watch on TV) , refuses to speak to patients because they lie, we need to mistrust news and forecasts of others. Contrarian investment strategy is workable because of the continous overreaction of man himself to companies he considers to have excellent or mundane prospects.  Uncertainty is part of investing and research in social psychology demonstrates how easily people are drawn together under conditions of uncertainty and even mild anxiety. Being also contrarian means not to invest in the hype and story stocks of the moment, you simple need to invest different from the majority and you need to buy the unloved stocks and selling the market's darlings. But going against the tide, is hard. The first man, who said the earth was not flat, was considered as an idiot. Nobody wants to be seen as an idiot! So you need to think independently. It is difficult to say for a fundmanager to a client, that he/she lost temporarily some of the customer's money on a small, obscure stock that nobody elso had bought. It is more accepted to tell that he lost money on Microsoft or on GE. "All the others were wrong too", the perfect umbrella. Value investing is dull, boring and always the same. You can beat the market by ignoring the herd, but it is not easy. Another reason, why not everyone is a value investor is patience. This is inherent to value investing. As Benjamin Graham wrote, 'Undervaluation caused by neglect or prejudice may persist for an inconveniently long time, and the same applies to inflated prices caused by over-enthusiasm or artificial stimulants.'. Cheap stocks can always get cheaper and expensive stocks can always get more expensive. You need to have a long term thinking of holding a stock or in our case of the process of mechanical value investing. Long term investors are a vanishing species. Modern investors concentrate too much on annual, quaterly valuation. For many fund managers, there is also pressure from customers and the benchmark paranoia . Many funds are judged whether they can beat the returns of a particular index. A manager who significantly underperforms the market averages for two or three years has a good chance of losing most of his or her investors. The late '90s were such a hard time for value investors, as they had to compete against the internet bubble story stocks. It was just difficult to invest in cold, non-growth industries. Most customers don't wait around to figure out if the fund manager has had just bad luck or is doing a poor investment process. But even the best-performing investors (as even Warren Buffett) go through (long) periods of significant underperformance. There's just nothing in the short term to do about this. There are also some regularty rules and practical limitations of many fund managers. Most of institutional investors must limit their ownership stakes to 5 or 10 percent of the total company. Purchasing even 5 percent of a company can push the price up, particularly for small and nano cap companies. So these investors can't invest in cigar butts or small deep value stocks. And these of course, are the most interesting bargains to buy. Most research analysts from Wall Street or London won't usually cover these smaller companies either. These shares don't trade enough to generate enough commissions to justify research coverage. People also like forecasts and stories.  Our 'experts' try to forcast the economy, the interest rate, unemployment rate, sectors that will do well, etc. But most economists don't have a clue what the future will be. There are just too many variables to build a reliable model on. And analysts are no better, their forecasts are dreadfull on short- and long-term issues.  According to David Dreman, this is the 'expert' way to lose money. Man is simply not a good configural processor of information. There is an information overload(internet,news,tv,etc.), which makes it almost impossible to make forecasts. But as said, people like stories and forecasts. Value investing is not based on forecasts, it is based on margin of safety. But that is just to dull for most of us. Conclusion : Value investing is simple, but apparently not for everyone... Philip Vanstraceele

the value investor seeks to purchase a security at a bargain price , the proverbial dollar for 50 cents. So Graham initiated an approach that remains vital today. Value investing rests on three key characteristics of financial markets : [More]