Introduction to the basic principles of value investing

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Warren Buffett is the most successful investor of all time, and for that reason alone he’s attracted a lot of attention during his long and illustrious career. Buffett has always been a proponent of a discipline that’s come to be described as “value investing.” Value investing was originally defined by Benjamin Graham and David Dodd. They thought of the discipline as having some very distinctive characteristics:

1) They described the stock market as a bi-polar character named “Mr Market”. Mr. Market always swings from extreme highs to lows, and depending on his mood will offer your prices on your shares which are way high or way low.

2) Despite Mr. Market’s mercurial nature, at the very basis of any stock is an intrinsic economic value which can be determined. To them, Value and Price are not the same thing on any given day, and therein lies the secret to successful trading.

3) The best way to make money is to buy a stock when Mr. Market is extremely manicly depressed and sells to you for a very low price. This usually happens around the time of scandals or negative economic news, which tend to cause knee-jerk reactions which generally lower prices. You sell the stock again when the share prices have reached or exceeded their intrinsic value, and Mr. Market is feeling overly upbeat.

The strategy is simple in theory, but complex in practice. Some of the most successful investors of all time have used value investing principles (Bill Miller, Warren Buffett, the late Bill Ruane). We’ll look into the discipline in more detail in future posts.

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