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Value Investing

In May 2022, I reviewed 3 books on value investing which I summarize below:

  • All about value investing
  • The Waren Buffet Way
  • The Art of Value investing

From reading these books, the following distinctions occurred to me:

  • there is a simple 2D value/price qudrant, with Graham stocks in top left, dogs on bottom left, MSFT on top right and Tesla/Zoom on bottom right.
  • there are 3 ways to values stocks: 1) net assets, 2) earning power, 3) growth value, the first one only becomes relevant in distressed situations where management destroyed earning power.
  • BV needs adjustment: RE * 1.25, Equipement * 0.5, Intangibles: 3 year of SGA?, Options
  • Growth value is intangible
  • Franchise/Moat is required to preserve earning power

I put some notes on IB financial statement items to go beyond earnings, growth, management.

In Nov 2022, I reviewed Equity Valuation, models from investment banks edited by Jan Viebig et al. The book starts witha description of DCF models and various metrics, a MC model, followed by a discussion of EP (Enterprise Profit) or EVA approaches vs Holt CFROI.

The CFROI computes a IRR based on all cashflows that were invested into the business, using inflation adjustments to reflect the time value of money. This in theory requires the accounts of the company for all years as well as expected terminal values of investments. The measure inclues all cash paid in, so that idle cash and impaired goodwill will reduce the CFROI.

The EP measure is just a NOPAT/assets - wacc. Note that the tax rate applied is not real since interest charge is not applied, and there is a choice to make between NOPAT inclusive of depreciation divided by NetAssets vs NOPAT / Assets grossed up by all amortization.

The author remarks that EP does not include goodwill, so that the overpriced aquisition of 3G licenses does not bear on Vodafone EP, whereas it weighs on its CFROI.

All about Value investing

All about value investing is a book by Esmee Faeber, an accounting professor who writes about investment.

When Security Analysis was first published 1934, Benjamin Graham defended some new ideas: - stocks are shares of businesses, and being able to fundamentally value the business helps arbitrage the market - animal spirits are strong in the market, and there are superlatively cheap and superlatively expensive stocks.The safest bets are to buy cheap, value stocks.

Since then, Esme Faeber distinguishes the following scale in order or rising P/B:

  • distressed, cigar stub stocks (discarded cigar stubs one finds on the street that still have one good puff in them)
  • value stocks
  • economic timing dependent (cyclical) stocks
  • garp (growth at a reasonable price)
  • growth stocks
  • momentum stocks

While Graham did not have a computer and never had the time to confirm his recommendations the idea that a fundamental value should be put on a stock is important.

Buffet keeps referring to Graham on value investing, and the few formulae Buffet shared, such as $P=EPS/(y-g)$ are much more mathematically sound than the incorrect linear regressions of Graham formula $P=EPS (8.5+2g)$ which he later complicated into $P=EPS (8.5+2g) . 4.4 / y$ to deal with higher rate environments.

Buffet also learned from the acquisition of the struggling textile Berkshire Hathaway that cigar butts are riskier than the rest, whereas good companies at a reasonable price are a more reliable value proposition.

Fundamental investing is the value to investors if there is no sucker to sell it to at an inflated P/E multiple. It does not prescribe a given P/E level like value investing, but it is clear from acquisitions by Buffet that he made the switch more than 40 years ago.

Graham's guidelines for investing in stocks


  • is earning yield twice the yield on AAA (premium might be an absolute number when yields are low) (avoid Bond arb)
  • is P/E less than 40% its average value compared to the past 5 years? (allows some future multiple expansion, avoids value traps)
  • is dividend yield more than 2/3 the corporate yield (ensure good governance/yield policy)
  • is stock less than 2/3 the BV
  • is stock price less than 2/3 the net current asset (current asset minus total debt)


  • is debt to equity less than one
  • is current ratio=current asset/current debt two or more
  • is total debt less than twice the net asset
  • is 10Y EPS growth greater than 7%
  • were there no more than 2 years out of the past 10 with earnings declines greater than 5%

source: Paul Sturm "What if Benjamin Graham had a PC?" SMart Money, March Esme Faerber, "All about value investing"

Some metrics above pre-date the Piotroski metrics but they are not justified by data analysis.

Also, note that Piotroski metrics are discrete, that very few stocks have a score of 9, and the criteria put so much weight on a single year evolution as to produce a different small portfolio every year. So, unlike a screen that selects 200 stocks and is stable year over year, its comparative performance over a decade or two is not statistically significant.


Notes contain material information that is not included in the statements:

  • stock options
  • leases
  • pensions
  • treatment of intangibles or depreciation
  • pro forma reporting choices

Warren Buffett way

The Warren Buffet Way is a book by Robert Hagstrom. He describes the influences to warren Buffet:

  • Benjamin Graham, a number oriented analytical investor, oriented towards low price stocks
  • Phil Fisher: an investor from the 30s who studied accounting and advocated “scuttlebutt” the collection of all possible data about a company. Fisher concentrated his bets on less than 10 stocks with 75% of positions often in 3 stocks. -Charlie Munger: an investor working in LA who became partner to WB in the 60s. Munger taught buffet that a great business at a fair price can be a lower risk than a terrible price at bargain price

The 12 tenets for business are:


  • is business simple and understandable?
  • does the business have a consistent operating history?
  • does the business have favorable long-term prospects?


  • Is management rational?
  • Is Management candid with its shareholders?
  • does management resist the institutional imperative?


  • focus on return on equity, not earning per share
  • calculate owner earnings
  • look for companies with high profit margins
  • for every dollar retained, make sure the company has created at least one dollar of market value

Market Value

  • What is the value of the business?
  • Can the business be purchased at a significant discount to its value?

The institutional imperative is the tendency for businesses to invest in the current thing, do like the rest of the industry irrespective of whether it makes sense.

Owner earnings are operating cash-flows with correct depreciation based on replacement cost amortization required to maintain the activity. Some capital intensive plants have old infrastructure with low depreciation due to inflation, so the numbers need to be checked.

cost cutting programs are indicia of corporate conspicuous consumption.

similarly, management effectiveness includes the increase of market value given retained earnings.

Against Diversification

Hagstrom makes the point that Buffet, like Fisher, thinks that portfolios should be focused rather than diversified. I don’t think this is born by statistical evidence.

He makes the following interesting expertement ou of 1200 stocks for the period 1987-1996

  • 3000 portfolios of 250 stocks, 0.65% sd, 11.4% to 16% perf, 63 beat the mkt
  • 3000 portfolios of 100 stocks, 1.11% sd, 10% to 18.3% perf, 337 beat the mkt
  • 3000 portfolios of 50 stocks, 1.54% sd, 8.6% to 19.1% perf, 549 beat the mkt
  • 3000 portfolios of 15 stocks, 2.78% sd, 6.75 to 26.6% perf, 808 beat the mkt

I assume that the market is the cap weighted performance of the 1200 stocks. That the market beats random portfolios means that there was over performance by large cap over small cap.

He communicates best and worst performance and standard deviation of return but no mean or median portfolio performance (which is key to understanding why beating the market was hard on average). Also, he did not test the 3 stocks portfolio that Fisher or Buffet had for a while. A 1 to 3 stock portfolios set would have massive return variance.

Buffet Way vs Statistics

Advocating that people use a very focused/high noise portfolio would result in half of the unskilled people believing they are skilled due to overperformance at the end of a few year period, and half the people who are skilled believing the opposite. Therein lie a problem, that the author does not consider what it takes to confirm that one is skilled.

Restricting one’s circle of competence leads to restricted investment domain and inferior performance fo all those but the lucky few who had the right circle. Superior performance can be achieved by developing one’s edge in the most promising field. The Fisher approach was developped in pre-internet age, it is described like a seat-of-the-pants “what worked for me” receipe rather than an optimized, cross-validated method.

Warren Buffet explains that focused portfolio make sense and diversification is for know nothing investor. Indeed, if stock returns are known to you with certainty, it makes sense to focus a portfolio. But this is not what Warren Buffet practiced: the cigar butt strategy chosen in the 60s was high risk as he self-admittedly found out: after much success he ended up with a concentrated bet into a failing textile mill business. It is not clear whether he was constrained to few bets by research capacity or by the lack of opportunity in the market. He might have taken too concentrated bets given the risks.

If one makes 100 uncorrelated bets per year, one can compute with some margin of certainty the accuracy of your bets. If you make 3 bets per year, it will take you 30 year to obtain similar information about your accuracy. It seems that Warren was running too few positions before he obtained sufficient data to assert that he had an edge, so he got lucky and the number of bets he made only allowed him to improve his investment strategy after more than a decade.

The Art of Value Investing

The art of value investing by Heins and Tilson is a book with short quotes/soundbites from value managers. These managers are:

  • tweedy brown Will Browne
  • T Rowe Price Preston Athey
  • Centaur Capital Zeke Ashton
  • Roumelll asset management Jim Rommel
  • Abingdon Capital, Bryan Jacobski
  • Advisory research Inc, Bruce Zessar
  • Al Frank Capital Management, John Buckingham
  • Akre Capital Management, Chuck Akre
  • Alatus Capital, Richard Vogel
  • Aquamarine Fund, Guy Spier
  • Ariel Investments, John Rogers
  • Artisan Partners, Dan O Keefe
  • Artisan Partners, David Samra
  • Artisan Partners, James Kieffer
  • Atlantic Investment Management, Alexander Roepers
  • Avenir Corp, Charles Mackall
  • Bares Capital, Brian Bares
  • Bestinver Asset Management, Francisco Garcia Parames
  • Browne Brothers Harriman, Timothy Hartch
  • Cambiar Investments, Brian Barish
  • Cannell Capital, Carlo Cannell
  • Canyon Capital, Mitchell Julis
  • Castlrock Management, Ellen Adams
  • Causeway Capital, Sarah Ketterer
  • D3 Family funds, David Nierenberg
  • Davis Advisors, Kenneth Feinberg
  • Daruma Capital Management, Marino Gordon
  • Defiance Capital, Francois Parenteau
  • Delafield Fund, Vincent Selecchia
  • Delafield Fund, Dennis Delafield
  • Deutsche Asset Management, Oliver Kratz
  • Diamond Hill Investments, Ric Dillon
  • Diamond Hill Investments, Chris Welch
  • Eagle Capital, Boykin Curry
  • Esplanade Capital, Shawn Krawetz
  • Eminence Capital, Ricky Sandler
  • Fairfax Financial, Prem Watsa
  • Fairholme Capital, Bruce Berkowitz
  • Fiduciary Management, Pat English
  • Fir Tree Partners, Jeffrey Tannenbaum
  • First Eagle Funds, Jean Marie Eveillard
  • First Eagle Funds, Matthew McLennan
  • First Pacific Advisors, Eric Ende
  • First Pacific Advisors, Steven Romick
  • First Willshire Securities, Scott Hood
  • GAMCO Investors, Mario Gabelli
  • Gardner Russo and Gardner, Thomas Russo
  • General American Investors, Spencer Davidson
  • Glenview Capital, Larry Robbins
  • Goldentree Asset Management, Steven Tannanbaum
  • Giverny Capital, Francois Rochon
  • GMO, Jeremy Grantham
  • GreenHaven Associates, Ed Wachenheim
  • Greenlight Capital, David Einhorn
  • Grisanti Brown & Partners, Christopher Grisanti
  • Harris Associates, David Herro
  • Harris Associates, Bill Nygren
  • Harris Associates, Clyde McGregor
  • Harris Associates, Edward Studzinski
  • Heartland advisors, William Nasgovitz
  • Highfields Capital, Jon Jacobson
  • Horizon Asset Management, Murray Stahl
  • Humingbird Value Fund, Paul Sonkin
  • JANA Partners, Gary Claar
  • Institutional Capital LLC, Jerry Senser
  • International Value Advisers, Charles de Vaulx
  • Invesco, Canon Coleman
  • Interpid Capital, Eric Cinnamond
  • Ivory Capital, Curtis Macnguyen
  • Khaner Capital, Lloyd Khaner
  • kovitz Investment Group, Jonathan Shapiro
  • Kynikos Associates, James Chanos
  • Lakeview Investment Group, Ari Levy
  • Legg Mason Fund, Bill Miller
  • Legg Mason Fund, Michael Mauboussin
  • Marathon Partners, Mario Cibelli
  • Mark Asset Management, Morris Mark
  • Markel Corp, Thomas Gayner
  • Matador Capital Management, Lisa Rapuano
  • Maverick Capital, Lee Ainslie
  • Metroploitan Capital, Jeffrey Schwarz
  • Mittleman Brothers LLC, Chris Mittleman
  • New South Capital, Steve Morrow
  • North Star Partners, Andrew Jones
  • O Shaughnessy Asset Management, Jim O Shaughnessy
  • Oaktree Capital, Howards Marks
  • Olstein capital management, Robert Olstein
  • Orbimed Advisors, Sam Italy
  • Osterweis Capital Management, John Osterweis
  • Osterweis Capital Management, Matthew Berler
  • Pabrai Funds, Mohnish Pabrai
  • Paradigm Capital, Candice Weir
  • Passport Capital, John Burbank
  • Pennant Capital, Lee Atzil
  • Pennant Capital, Alain Fournier
  • Perkins investment management, Tom Perkins
  • Polaris Capital, Bernard Horn
  • Presidio Fund, Kevin O Boyle
  • Pzena Investment Management, Richard Pzena
  • Royce & Associates, Whitney George
  • RS Investments, Andrew Pilara
  • RS Investments, Joe Wolf
  • River Road Asset Management, James Shircliff
  • Sabre Value Management, Aaron Edelheit
  • Sellers Capital, Mark Sellers
  • Scharf Investments, Brian Krawez
  • Scout Capital, James Crichton
  • Scout Capital, Adam Weiss
  • Sheffield Asset Management, Brian feltzin
  • Soapstone capital, Jed Nussdorf
  • Societe Generale, James Montier
  • Solas Capital, Tucker Golden
  • Southeastern Asset Management, Staley Cates
  • Southeastern Asset Management, Mason Hawkins
  • Starboard Value, Jeffrey Smith
  • Starboard Value, Peter Feld
  • Sterling Capital Management, Timothy Beyer
  • TAMRO Capital, Philip Tasho
  • Tetrem Capital, Daniel Bubris
  • The Baupost Group, Seth Klarman
  • The London Company, Stephen Goddard
  • Thornburg Investment Management, William Fries
  • The Vice Fund, Charles Norton
  • Third Avenue Management, Jason Wolf
  • Third Avenue Management, Michael Winer
  • Third Avenue Management, Amir Wadhwaney
  • Thunderstorm Capital, John Dorfman
  • Tiger Management, Julian Robertson
  • Tocqueville Asset Management, Robert Kleinshmidt
  • Trapeze Asset Management, Randall Abramson
  • ValueAct Capital, Jeffrey Ubben
  • VN Capital, James Vanasek
  • Vulcan Value Partners, CT Fitzpatrick
  • Wasatch Advisors, Ralph shive
  • Wellcap Partners, Alan Schram
  • Weitz Funds, Wally Weitz
  • Williamson McAree Investment Partners, Robert Williamson
  • Williamson McAree Investment Partners, Edward McAree
  • Wintergreen Fund, David Winters
  • Robotti & co, Robert Robotti
  • Yacktman Asset Management, Stephen Yaktman