7 Value Investing Strategies Known to Obsessed Fans

“What stock should I buy?”

Even before we ask that question, we must know the different type of stocks.

And how you should treat them from start to finish – that is the value investing theme.

1. Cigar Butts

Benjamin Graham espoused the philosophy of buying average companies and dirt-cheap prices. But Walter Schloss made an entire career out of it.

Walter Schloss’ criteria were:¹Factors needed to make money in the stock market by Walter Schloss, 1994

• Use book value. They are more stable than earnings.

• If you buy earnings, you have to know a lot about the company.

• Beware of debt.

• Look for mult-year lows, not just 52-week lows.

• Before selling, reevaluate the company. Compare with book value again.

• Scale up and scale down.

2. Moats

Charlie Munger is the patron saint of high-quality investing.²Also see: Warren Buffett – Value Investing Themes

Warren Buffett talks about 3 types of businesses:

• Great Business: Capital light. Has excellent return on capital (ROC) because of a moat due to a low cost of production, or famous brands.

The moat is durable because, its industry is stable and it’s not dependent on superstar managers.

Example: See’s Candy, Microsoft, Google, Nestle India, HUL.

• Good Business: Capital heavy. Decent ROC. Also has moats. Example: Utilities like Indraprastha Gas.

• Gruesome Business: Very capital heavy. Poor ROC. Moats don’t endure. Example: Jet Airways.

• There are 3 types of businesses – the great, the good and the gruesome:³Berkshire shareholder letter, 2007, P6

Notes

• In the case of great businesses, organic growth is optional. In fact, it is unlikely. Because lightning doesn’t strike twice. Very high ROC is hard to repeat again.

Hence, the investor has to create her own inorganic growth. In her portfolio.

• Stable industries tend to have low growth rates.

Also, the number of players tends to shrink over time. And profit pool tends to consolidate in the hands of the strongest player.

• A good way to judge capital intensity is to compare depreciation with capital expenditure. In this type of business, capex > depreciation.

• Oddly, such a business may have a high growth rate! 🙂

3. Growth Story

Peter Lynch talks about 6 types of stocks:⁴One Up On Wall Street by Peter Lynch

• Slow Growers: These are old companies, whose days of growth are now behind them.

• Stalwarts:

• Fast growers:

• Cyclicals:

• Turnarounds:

• Asset plays:

4. Special Situations

5. Magic Formula

Note: Warren Buffett

The Oracle of Omaha has used many of these themes, over his career.

Secret 1: Small Sums of Money

Only: Wonderful

• Old school cigar butts are difficult to find now. You’ll only find them when the stock market is cheap. And precisely then, wonderful companies will also be cheap. Go for the latter.⁵Berkshire AGM, 2001, Afternoon session, Q33, 2:26:57

Either: Cigar butt or Wonderful

• “Either is fine. Cigar butts, better for small sums. Wonderful companies, better for large sums.”⁶Personal correspondence with Shai Dardashti, 2007, P5

Both: Cigar butt + Wonderful

• I’d look among classic Graham stocks – very low PEs and maybe below working capital. I’d comb that sort of a list. There are thousands of potential opportunities. I’d do far better percentage wise, than I do now.

If I found a wonderful company and I was really convinced about its future, I’d buy that also.

Incidentally, I bought GEICO in 1951, when I had $10,000. It was exactly the sort of stock that Graham wouldn’t buy. It was selling way above book value. But I’m glad I did it.⁷Launch of Berkshire insurance in India, 2011, YouTube video, 9:52

Also: Speculators