Welcome to the Deep Dive, where we take a monumental
stack of research, academic papers, and historical
insights, and we distill them into the most potent
knowledge transfer available. We're giving you
the shortcut to being well -informed, not just
about what happened, but, you know, why it still
matters right now. And today, we are plunging
into the investment world's most enduring and,
I think, profoundly influential philosophy, value
investing. It's a system, really. It claims to
take the guesswork out of the market. How so?
The entire paradigm is focused relentlessly on
one thing, buying securities that appear underpriced.
But not just based on a hunch or a hot tip. No,
not at all. It's through methodical, rigorous,
fundamental analysis. And it's an approach that
has produced some of the greatest wealth creators
in history. OK, let's unpack this immediately.
If we establish the bedrock of this whole approach,
it all comes down to buying an asset for less
than its true underlying worth. Right. What we
call intrinsic value. And that term, intrinsic
value, it can sound a little elusive, can't it?
Especially in today's fast -moving markets. It
sounds elusive because it's an estimation. But,
and this is the key part, it's an estimation
based on verifiable facts about the business
itself. So separate from all the emotional noise
of the market. Exactly. Think of it like this.
What would a highly rational, fully informed
private buyer pay for the entire company today?
That's your intrinsic value. And the discipline
isn't just about finding that number. No. It's
about ensuring you buy with a protective buffer.
That protective buffer being, of course, the
famous concept from Benjamin Graham. The margin
of safety. Precisely. The margin of safety is
that gap, that discount between the market price
and your calculated intrinsic value. So if you
think a stock is worth $100. And you only pay
$60 for it, that $40 difference, that's your
margin of safety. You know, that sounds less
like a financial theory and more like a fundamental
rule of engineering, which I really appreciate.
It's a perfect analogy. You always build in more
strength than you think you need. It's a protection
against, what, a calculation error? A calculation
error, yes, but also against the sheer unpredictability
of the future, the world. Right. An engineer
designs a bridge to handle 100 tons, but they
build it to withstand 150. That 50 -ton buffer,
that's what protects you. Against what? Poor
materials, maybe? Poor materials, an unexpected
traffic load, or just a simple miscalculation
in the initial design. In investing, that buffer
protects you if the company's earnings are a
bit weaker than you projected. Or if the whole
market just goes into a panic because of a recession.
Exactly. It drives all prices down unexpectedly.
Your margin of safety is what lets you sleep
at night. And what's truly fascinating to me
is that this entire strategy... which has proven
itself for nearly a century, is just a direct
rejection of one of the dominant theories of
academic finance. Oh, it's the ultimate intellectual
conflict. You're talking about the efficient
market hypothesis, right? The EMH. That's the
one. The EMH posits that because all information
is instantly available to millions of hyper -rational
traders, all securities are priced perfectly
and accurately at all times. So if the price
is $100, The value is $100. There are no deals
to be had. Correct. But the value investor comes
along and says, Wait a minute. Human beings run
the market. And human beings are emotional. They're
subject to fear and greed and just wild short
-term thinking. So the market isn't always rational.
Exactly. Value investing proposes that the market
is often irrational, creating these little windows,
these opportunities where securities are, in
fact, not accurately priced. And those moments
are caused by what? Panic? Neglect? All of the
above. Panic, neglect, or sometimes just a simple
lack of understanding of the underlying business.
The ability to spot those temporary mispricings.
That's the whole game. And this movement, this
whole philosophy, it didn't start with some flashy
hedge fund in the 80s. It started in a classroom.
It did. The foundation was laid at Columbia Business
School by Benjamin Graham and David Dodd. This
was way back, starting around 1928. And then
it was all formalized in their, well, their legendary
1930s. for text security analysis. Which is,
I mean, a dense, rigorous book. It really set
the standard for how professional analysts should
look at companies. It's interesting. Our sources
are very clear that Graham himself never actually
used the phrase value investing. That's right.
It was coined later to describe his ideas. Which,
ironically, might have led to some misinterpretations
over the years. For sure. The simplistic idea
that he was just telling people to buy the absolute
cheapest stocks they could find, regardless of
the quality of the business. That distinction
is so important, and it kind of foreshadows the
whole evolution of the strategy we're going to
talk about. It does. So our mission today is
to trace this whole intellectual history. We
want to understand Graham's rigid foundation,
then see how the key figures who came after him
adapted it. People like Warren Buffett and Charlie
Munger. Exactly. And then we'll explore how modern
quantitative and technological methods have,
well, completely reshaped what it even means
to calculate intrinsic value today. Right. Let's
dive in. Let's do it. Let's dedicate some serious
time to the bedrock here in Section 1. The foundational
work of Benjamin Graham and David Dodd. They
did more than just invent a strategy. They really
professionalized the discipline of security analysis.
They did. They separated it from the casino -like
speculation that really dominated Wall Street
before the Great Depression. And Graham is absolutely
the towering figure here, the father of value
investing. No question. His work survives primarily
through two monumental texts. First, as you said,
security analysis in 19... which he co -authored
with Dodd. That was a dense one, the professional
academic blueprint. Right. And then his later
work, The Intelligent Investor, which took those
core concepts and translated them into actionable,
accessible principles for the individual investor.
Which is why it's earned a permanent place on,
well, pretty much every successful investor's
bookshelf. It really has. So what was so revolutionary
about securing analysis at the time? What void
did it fill that made it the definitive guide
for decades? Before Graham, Wall Street analysis
was often, well. qualitative. It was based on
reputation, industry trends, or maybe the charisma
of a company's management. The story. The story,
exactly. Graham's lasting contribution was his
intense, almost obsessive emphasis on the quantifiable.
The numbers. He mandated that analysts focus
on things that could be objectively measured
and verified. Primarily, that meant reported
earnings and book value. So he was telling people
to stop listening to the CEO's promises and start
actually reading the financial statements. Yes.
Treating a stock like a fractional share of a
real business, not like a lottery ticket. That's
the perfect way to phrase it. His methodology
intentionally minimized those qualitative factors.
Why? He believed that trying to judge the quality
of a management team or guessing the likelihood
of success for some new, exciting product launch,
it just introduced too much subjectivity, too
much speculation. You wanted cold, hard, verifiable
numbers. Exactly. And in his early years, especially
in the wake of the 1929 crash, he was focused
on buying assets that were basically undergoing
liquidation. So he wanted to buy companies for
less. Than their net current asset value. Right.
Essentially treating the stock as if it were
worth more dead than alive. That's what people
now call net net investing or deep value. You're
buying something for less than its easily liquidated
inventory, cash and receivables after you subtract
all the liabilities. That's the classic, highly
conservative Graham approach. And to find those
opportunities, he established these very objective,
very measurable screening criteria. And these
were designed to filter out. the high flyers,
the popular stocks. And instead focus on the
neglected, the depressed or the genuinely misunderstood
companies. Let's walk through that checklist
because these original criteria are still the
starting point for countless systematic strategies
today. What was Graham actually telling people
to look for in the 1930s? The screen was highly
statistical. And very conservative. First, he
looked for stocks trading at a significant discount,
sometimes 30 percent or more to their book value.
Or tangible book value, which is even stricter.
Right. Book value, just to be clear, is the accounting
value of assets minus liabilities. Tangible book
value then excludes any intangible assets, making
it, as you said, even more conservative. So that
ensures you're buying something that has physical,
verifiable assets backing up the price. Precisely.
He also favored companies with high dividend
yields. Why dividends specifically? Well, dividends
provided concrete, immediate evidence that the
company was profitable and that it was shareholder
friendly. It reduced your reliance on future
capital appreciation, which is always uncertain.
Makes sense. And critically, he looked for low
valuation ratios, specifically low price to earnings,
P .E. multiples and low price to book P .B. ratios.
A low P .E. ratio. That's a pretty clear sign
of neglect, right? It suggests the market is
currently paying very. little for every dollar
of the company's earnings. It is. So his specific,
very stringent checklist included a few things.
First, purchasing firms that had steady profits
over multiple years. Stability was non -negotiable.
Second, as we said, they had to be trading at
low prices relative to book value. Third, they
needed low P .E. ratios, often in the single
digits. And finally, and this was crucial for
defense against insolvency, they had to carry
relatively low debt. So it was really a financially
conservative filter. Extremely. It was designed
to ensure you were buying a cheap company, but
not necessarily a failing one. Every single one
of those layers, from the steady profits to the
low debt, it all serves to enhance that one single
most critical concept. The margin of safety.
It's the ultimate safeguard. Absolutely. If you
adhere strictly to this checklist and you buy
a stock well below its calculated intrinsic value,
you're creating a buffer. A buffer against the
three main threats. Which are? Unforeseen poor
outcomes, broad market volatility, and just as
important, your own analytical error. And without
that buffer? Without that buffer, Graham argued,
you are just engaging in financial speculation.
You're not doing disciplined investing. The value
investor is willing to be patient, knowing they've
bought a dollar bill for 70 cents or maybe even
50 cents, and time is on their side while the
market eventually, hopefully, corrects its irrational
pricing. The clarity of Graham's methodology
is powerful, but as we move into section two,
it's clear the core insight. that price and value
are not always the same thing. It actually predates
him by centuries. Oh, for sure. We need to place
Graham in this broader historical context and
then see how the definition of value itself had
to evolve after his lifetime. Showing the lineage
proves the concept is timeless. It really is.
We can trace the recognition of this price versus
value divergence all the way back to the financial
markets of the 1600s. That's astonishing. How
far back are we talking in concrete terms? We
can point to the 1690s and specifically to the
famous writer and commentator Daniel Defoe. The
author of Robinson Crusoe. The very same. He
observed the stock of the East India Company
trading at what he called a ludicrous price over
300 percent more than its face value. Wow. And
Defoe wrote about how this valuation suggested
and I'm quoting here. No material difference
in intrinsic value between the shares being bought
for huge sums and those that cost much less.
So he's saying the underlying worth hasn't changed,
just the price people are willing to pay for
it. Exactly. It shows that the concept of overpaying
for an asset, and thus the idea of a true underlying
worth, existed three centuries before Graham
even started teaching. That anecdote just grounds
the whole discussion, showing that human nature
in markets really hasn't changed a bit. So then
we jump forward to the Victorian era with someone
who has been retrospectively labeled a value
investor. That would be Hetty Green, often called
America's first value investor. She lived from
1834 to 1916. And she was a renowned contrarian.
A legendary one. Her standard operating procedure
was to buy unwanted, often depressed assets.
It could be undervalued land, undervalued debt,
or stock at extremely low prices. And then what?
Just wait. and simply hold them until the market
changed its mind. She famously said that she
kept these assets until they go up in price and
people are anxious to buy. That patience and
contrarian focus on a low purchase price, those
are core tenets of the value ethos. They absolutely
are. And institutionally, we know that there
was an investing firm operating at the same time
as Graham that followed these exact same principles.
Yes, the firm Tweedy Brown. It was founded in
1920. and is often described as the oldest value
investing firm on Wall Street. And their founder,
a man named Forrest Berwyn Bill Tweedy, found
a really specific niche. He did. He focused on
buying smaller, often family owned companies.
And because these stocks traded in really low
volumes and had fewer buyers, the sellers were
often desperate. Which allowed Tweedy to acquire
shares at steep discounts to their book value.
It's a perfect example of capitalizing on market
inefficiency caused by illiquidity, a lack of
buyers. And they must have been effective. Because
the sources note that Tweedy and Graham actually
worked in the same building and became friends.
They did. They both operated from 52 Broadway
in New York City. And that intellectual exchange
between the academic formalizer, Graham, and
the highly effective practitioner, Tweedy, was
critical to cementing these ideas in the real
world. Now let's discuss the surprising independent
developer of very similar ideas, John Maynard
Keynes. Yes. We usually associate him with macroeconomics,
not picking individual stocks. And Keynes is
a profound example of practical learning, just
trumping abstract theory. While he was managing
the endowment of King's College, Cambridge, in
the 1920s, he started out with a market timing
strategy. Trying to predict the broad movements
of the economy. And he failed, spectacularly.
So he pivoted. And how did that pivot align with
what Graham was thinking? After he abandoned
his failed attempts at market timing, Keynes
shifted his focus. He started concentrating on
a very small, select number of undervalued stocks
that he knew exceptionally well. So he stopped
chasing the big picture macro calls and started
doing microvaluation. That's it. He targeted
undervalued stocks, often small and mid -sized
companies, and particularly those in industries
that were considered, you know. dull or out of
favor. Like mining in autos during the Great
Depression. Exactly. So he switched from trying
to time the flow of the entire river to carefully
examining the quality of the individual boats
floating in it. And the long -term results were
undeniable. Despite that rough start, his portfolio
managed to beat the market averages by an incredible
6 % annually over more than two decades. It was
just confirmation of the power of focus valuation
over speculative timing. And the sources confirm
he developed this completely independently of
Graham and Dodd. Yes. The archival review at
King's College suggests there's no evidence of
collaboration. His theories were developed on
his own and weren't widely known until decades
after his death in 1946. But the considerable
overlap in terms... In terms and concepts, especially
the focus on intrinsic value, it suggests the
principles are just universally valid. They are.
Which brings us to the core evolution of the
idea, the post -1970s world. Graham's original
reliance on book value started to become a major
liability as the economy shifted. This is the
critical transition point. Book value assets
minus liabilities. It works beautifully when
your assets are tangible. Factories, trucks,
inventory, oil reserves. Exactly. It works a
lot less well when the company's primary value
resides in its head, not in its physical plan.
We're talking about the rise of technology and
service sectors, where the assets are things
like patents, brands, copyrights, or management
expertise, intangible assets. And this creates
two massive problems for Graham's original framework.
First, intangible assets are incredibly difficult
to quantify reliably. And second, they often
won't survive a company breakup. If a manufacturing
firm goes bust, you can sell the factory. If
a tech firm goes bust, how much is their code
or their brand equity worth? Often nothing. Right.
And in fast changing industries like software
or personal computers in the 80s, the value of
those assets could suffer permanent impairment
almost overnight because of disruptive innovation.
Yesterday's cutting edge patent is tomorrow's
worthless scrap of paper. Absolutely. So the
balance sheet just stops telling the whole story.
If we can no longer rely on physical assets to
represent intrinsic value, how do we adapt the
core principle of valuation to the modern knowledge
economy? And that is the very... problem that
led to the modern solution. Which is the discounted
cash flow model or DCF. Right. The DCF model
shifts the focus entirely from past assets to
future earnings potential. The definition of
intrinsic value is reformed. It becomes the sum
of all future cash flows the business is expected
to generate. Discounted back to the present day
to reflect the time value of money and risk.
Exactly. So instead of looking at the factory
they built in 1950, you're looking at the revenue
stream they will generate until 2050. This allows
you to value those intangible assets, future
growth, competitive advantages, all the things
that Graham's strict balance sheet rules kind
of missed. It does. But it introduces this new
problem of valuation ambiguity, which we'll circle
back to. Because now your valuation is heavily
dependent on your own assumptions. major input
assumptions. The estimated growth rate of the
business, the discount rate you apply to reflect
risk, and the terminal value you assign to the
business beyond your forecast period. And if
two analysts use even slightly different assumptions
for those three inputs. They can arrive at wildly
different intrinsic values for the very same
company. So the DCF model is a powerful tool,
but it also relies on subjective forecasting.
Which makes it the source of so much analytical
error and debate today. That challenging transition
from the certainty of the balance sheet to the
prediction of cash flows, it leads us perfectly
into section three, the modern approaches. Right.
We see the legacy kind of split into two major
methodologies, the systematic, which uses technology
to run gram screens, and the qualitative, which
uses human judgment to refine the definition
of quality. Let's start with quantitative value
investing. Quantitative or systematic value investing
is basically Graham's objective rules -based
approach, but supercharged by modern computing
power. So it involves rigorously analyzing massive
data sets. Financial statement line items, economic
metrics, even unstructured data like news reports,
all to systematically screen for undervalued
traits. This sounds like a direct attack on human
error. Right. We're using statistical finance,
machine learning, behavioral finance. all to
find undervalued stocks. That's the core mission.
Quantitative investing seeks to replace that
slow ad hoc stock by stock analysis done by a
human with a massive data driven system. And
the goal is to eliminate cognitive biases. Exactly.
Humans are notoriously bad at objectivity. We
suffer from confirmation bias, recency bias,
anchoring. A rules based system executed by a
computer doesn't get greedy or fearful or emotionally
attached to a stock. It's interesting that Graham
himself seemed to acknowledge the need for this
kind of systemization a long, long time ago.
He did. Later in his life, Graham admitted that
relying on detailed individual financial analysis
of single stocks was probably unlikely to produce
superior risk adjusted returns consistently.
So what did he recommend instead? He advocated
for a rules based approach. One focused on constructing
a well diversified portfolio using objective
financial factors. The quantitative movement
is simply realizing his ultimate conclusion,
but with far superior technology. Can we look
at some real world examples of how this quantitative
screening works, maybe even in its simplest forms?
Sure. We can start with Joel Greenblatt's famous
magic formula investing. It's a highly simplified
illustration, but it gets the point across. OK.
It systematically ranks and buys companies based
on just two simple factors, earnings yield and
return on invested capital. So the idea is to
buy good companies at cheap prices systematically.
That's it. It's a very easy to understand filter,
but more sophisticated. modern practitioners,
they evaluate dozens, even hundreds of metrics
at the same time. And a key text in this field
is James O'Shaughnessy's What Works on Wall Street.
A classic. It provides comprehensive backtesting
of all these different quantitative value strategies
with data spanning from 1927 all the way through
2009. And what did he find? These studies confirm
that simple value factors, when you apply them
consistently and systematically across large
pools of data, they tend to outperform over long
time frames. So that's the systematic data -driven
path. Now let's pivot to the other evolution,
the qualitative shift driven by Graham's most
famous disciples, Warren Buffett and Charlie
Munger. This is perhaps the more publicly recognizable
face of modern value investing. For sure. And
it represents a pivotal moment where Graham's
initial rigidity that focused on statistically
cheap cigar butts that had one last puff left
in them was abandoned in favor of quality. Buffett
credits his initial success to Graham. But the
philosophy evolved dramatically when Charlie
Munger became a key partner at Berkshire Hathaway
in the 1970s. Munger famously focused on the
non -quantifiable elements. He looked for companies.
with qualities that ensured long term durability,
even if the stock wasn't statistically dirt cheap.
Munger forced Buffett to ask a much harder question.
Why buy a stock that's 50 percent below its intrinsic
value if that intrinsic value is eroding rapidly
because of competitive pressure or obsolescence?
Better to pay a fair price for something whose
value is growing. Exactly. Munger emphasized
companies with robust qualitative qualities,
sustainable competitive advantages or a moat,
as Buffett calls it, and long term growth potential.
They sought businesses that could compound value
over decades. This influence caused Buffett to
fundamentally reduce his emphasis on just those
statistically cheap assets. He recognized that
cheap. often just means structurally impaired.
The cheap price often turns out to be a value
trap. The price is low because the business is
bad or it's getting worse, meaning the intrinsic
value you calculated is actually on its way to
zero. And this shift was all crystallized in
one of the most quoted sentences in investment
history. Warren Buffett's updated philosophy.
It's better to buy a great company at a fair
price than a fair company at a great price. And
that one statement completely redefined value
investing. It did. It emphasized that quality
and durability are themselves components of the
margin of safety because they secure those future
cash flows. It connects right back to the DCF
model we were talking about. The growth component
matters immensely. You want a company whose future
cash flows are highly predictable and durable.
Exactly. And beyond the analysis, the source
material notes that perhaps the most valuable
component shared by all successful value investors
is simple temperament. Meaning emotional stability
in the face of market mania. That's it. Buffett
recognizes that markets are driven by emotional
extremes, fear and greed, which is what creates
the mispricings in the first place. And his famous
advice is the guide to that temperament. Be greedy
when others are fearful and fearful when others
are greedy. And that requires incredible emotional
stability. patience. It enables the value investor
to stick rigorously to their intrinsic value
calculation, even when everyone else is panicking
and dumping the stock. Or conversely, getting
euphoric and bidding the price up to totally
unsustainable levels. It's the key to the whole
thing. That sense of disciplined temperament
and patience is the thread that runs through
Section 4, the pantheon of value investors. This
is not just a list of names. It's an intellectual
lineage. Right. It traces how Graham's principles
were put into practice across different decades
and different market cycles. It's the super investors
of Graham and Doddsville roster showing the direct
output of that one Columbia classroom. And the
immediate lineage of Graham's teaching assistants
and employees is just profound. Let's start with
those who work directly alongside the master.
OK. We can begin with Irving Kahn, who served
as one of Graham's teaching assistants back in
the 1930s. Kahn was a decades -long friend and
a close contributor. He actually provided research
for both security analysis and the intelligent
investor. He did. He later co -founded Kahn Brothers
& Company, a dedicated value investing firm,
and remained its chairman until his death at
the remarkable age of 109. Wow. That longevity
is a testament to the safety that's inherent
in the methodology. And then there's Walter Schloss.
who is maybe the definition of the self -made,
strict Graham disciple. Schloss is the quintessential
deep value investor. He started as a runner on
Wall Street, attended Graham's night courses,
and then worked at the legendary Graham -Newman
partnership. And he strictly adhered to Graham's
statistical approach, right? He prioritized low
prices over any qualitative factors. Absolutely.
He ran his own firm for nearly 50 years and was
featured prominently by Buffett in his 1984 speech,
confirming that Schloss's success was achieved
simply by buying statistically cheap stocks and
being incredibly patient. The sources also highlight
the firm that Graham himself preferred to use.
That would be Tweedy. Brown, the oldest firm
we mentioned earlier, Christopher H. Brown, who
ran the firm for years, was deeply committed
to Graham's principles. The Wall Street Journal
confirmed Tweedy Brown was Benjamin Graham's
favorite brokerage firm. That's right. And Brown
also wrote The Little Book of Value Investing,
ensuring the ideas remained accessible to new
generations. Their funds have a long documented
history of beating the market averages. Now,
moving internationally, we had Peter Cundall,
who applied these strict principles to the Canadian
market. Cundall was a highly respected. Canadian
value investor who maintained Graham's stringent
criteria. His Cundall value fund gave Canadian
investors access to this methodology. And he
got high praise from Buffett himself. He did.
Warren Buffett indicated that Cundall had the
credentials and the approach that Buffett looked
for in a chief investment officer. That's about
as high praise as you can get. For a modern example
that really captures the drama of the margin
of safety, we have to talk about Michael Burry.
Of course. Burry, the founder of Scion Capital,
cemented his fame by being one of the first investors
to recognize the systemic failure brewing in
the subprime mortgage market. Famously featured
in the big short. Right. And his approach, which
involved incredibly deep analysis and a focus
on massive downside protection, was rooted entirely
in Graham's text. Burry has explicitly stated
that his investment style is 100 percent based
on the concept of a margin of safety from security
analysis. He's a living example of how the principles
can be. applied to complex, modern financial
products. He really is. And the academic lineage
at Columbia didn't just stop when Graham retired.
It continued through the professors who came
after him. The school became an intellectual
factory for value managers. Graham taught Buffett
from 54 to 56. Two decades later, a professor
named Roger Murray was teaching value investing
to future superstars like Mario Gabelli. And
later, Bruce Greenwald arrived. Greenwald became
a leading contemporary voice, producing his own
protégés like Paul Sonkin. Columbia Business
School's enduring emphasis on this valuation
methodology really makes it a central node for
this school of thought globally. Let's look at
the other major lineage, the one that stems from
the mutual series funds. This tradition began
with Max Hein, who founded the Mutual Shares
Fund way back in 1949. Heinz's great success
was then continued by his protege, the legendary
value investor Michael F. Price. Price was known
for his aggressive activism and forensic accounting.
Yes, often focusing on distressed securities
and complex restructurings to maximize shareholder
value. Even after Mutual Series was sold to Franklin
Templeton in 96, the disciples of Hein and Price
carried on that tradition of deep... contrarian,
event -driven value investing. And one of those
Mutual Series alumni wrote a book that has become
this rare, highly sought -after classic. That
is Seth Klarman, an alum of Mutual Series and
the founder and president of the Botpost Group.
And the book is Margin of Safety, Risk -Averse
Investing Strategies for the Thoughtful Investor.
Right. And because it's out of print, copies
have become investment classics themselves. They
often sell for well over $1 ,000 used. Wow. And
why is the book so revered? Because Klarman's
philosophy emphasizes the preservation of capital
above all else. He ensures that the margin of
safety concept is applied not just to valuation,
but to every aspect of portfolio management.
Beyond these strict lineages, the sources highlight
several other notable investors whose methods,
while distinct, still orbit that core value principle.
Right. Like Lawrence Tisch, who led Lowe's Corporation
for over five decades. Fortune magazine famously
described him as the ultimate value investor
and a brilliant contrarian who saw value where
others missed it. Often investing in deep, cyclical
businesses during periods of maximum pessimism.
And Lowe's Corporation has demonstrated the long
-term effectiveness of that patience. By 2012,
they had reached over $14 billion in revenues
and assets, over $75 billion. Then we have someone
who manages one of the world's largest pools
of private capital. that would be michael larson
the chief investment officer for cascade investment
which manages the personal fortune of bill gates
and the bill and melinda gates foundation endowment
larson is a highly private value investor known
for disciplined long -term asset selection and
though his specific strategies are confidential
his firm has consistently rivaled or even outperformed
berkshire hathaway's returns which proves the
methods work even when you're managing immense
pools of wealth. It does. Let's discuss Martin
J. Whitman, whose approach is highly defensive
and, well, almost entirely dismissive of macro
forecasting. Whitman's strategy is called safe
and cheap, or the financial integrity approach.
He focuses relentlessly on acquiring common shares
of companies that possess extremely strong financial
positions. So low debt, high liquidity. Exactly.
And at a meaningful discount to their estimated
net asset value or NAV, his philosophy asserts
that it's generally futile to pay attention to
macro factors like GDP or interest rates. Right.
Because attempts to predict their movements are
usually wrong and they just distract the investor
from the hard work of actually valuing the specific
business in front of them. That must simplify
the process dramatically. Just ignore the noise.
Focus solely on the company's balance sheet strength.
Precisely. Now, we can circle back to Joel Greenblatt,
who we mentioned earlier. He's known not just
for his simple quantitative formula, but for
specializing in specific types of market confusion.
Special situations, right? Yes. Greenblatt achieved
over 50 % annual returns for a decade at Gotham
Capital by focusing on these special situations.
Things like spinoffs, mergers, asset sales. Right.
Events that often create temporary uncertainty
or require complex legal understanding, causing
the broader market to undervalue the components
or the newly independent company. Greenblatt
specialized in understanding the mechanics of
these events to capture the value that was unlocked.
Finally, we have to emphasize the strict financial
discipline taught by the global value managers
Charles Devol and Jean -Marie Evillard. They
are famed global value managers known for achieving
outstanding risk -adjusted outperformance over
decades. And their non -negotiable principle
goes right back to temperament and patience.
Investors should never use margin or leverage.
And why is this such a fundamental rule for them?
They label the use of leverage as outright speculation.
Because value investing is predicated on patience.
You're waiting for the market price to converge
with your calculation of intrinsic value. Leverage
or using borrowed money introduces a mandatory
timeline. If you use leverage and the stock price
moves against you, your lender can issue a margin
call, forcing you to liquidate at the worst possible
time. It completely compromises your ability
to be patient. It turns a long term investment
into a short term trade based on timing. And
by eliminating leverage, you secure your ability
to hold that dollar you bought for 50 cents until
the market finally agrees with your assessment.
That separation between discipline analysis and
forced speculation sets the stage perfectly for
our final section, Section 5. The historical
record is compelling, the disciples are legendary,
but we need to address the hard performance data,
the modern metrics required, and the persistent
legitimate criticisms of this strategy. And if
we look at the evidence of value performance,
the academic research is remarkably consistent,
especially when you track simple strategies over
decades. And what does that consistency show?
Numerous studies have consistently found that
value stocks, so those defined by low key or
low PB ratios, they outperform growth stocks
and the overall market index when tracked over
long periods. And some of this analysis goes
all the way back to the 19th century. It does.
This isn't a short term fad. It appears to be
a systemic market anomaly. Is this overperformance
uniform across the market, though? Do mega cap
value stocks outperform just as well as the smaller
ones? That's a key nuance. A review of U .S.
market data from 1990 to 2015 found that the
overperformance of value was significantly more
pronounced in stocks for smaller and mid -sized
companies than for the large, widely followed
companies. So the market inefficiencies are more
frequent and dramatic outside of the intensely
scrutinized S &P 500 giants. Naturally. And of
course, the real world. confirmation came from
Buffett's famous speech where he profiled the
results of Graham's disciples. Right. Confirming
that buying businesses below intrinsic value
is a sustainable long term road to success. The
track record of those super investors proved
the methodology works. But we have to confront
the critics because value stocks do not always
beat growth stocks. The late 1990s tech bubble
is the classic example. Value lagged dramatically
while growth soared for years. It did. And this
leads to the fundamental question that academic
finance poses. If value consistently outperforms
over time, why isn't the market technically efficient?
And if it is, what explains the outperformance?
So what's the dominant academic criticism? It's
known as the risk -based explanation. It argues
that the outperformance of value doesn't imply
market inefficiency. It might simply mean that
value stocks are inherently riskier. How so?
Well, perhaps because they're smaller, more indebted
or facing more structural headwinds. And so they
require a greater return premium to compensate
investors for bearing that extra risk. So essentially,
you're just getting paid extra to hold what is
statistically more likely to fail. That's the
argument. And furthermore, research by Foye and
Miramore in 2016 suggested that the factors leading
to value stock outperformance might be heavily
country specific, which complicates applying
a universal value factor model globally. And
here's the core practical criticism. that every
value investor has to face. The risk in relying
purely on low prices. The value trap problem.
This is critical, especially for the retail investor
who is just relying on simple screens like a
low P .B. ratio. Price centric value investing
often leads people to misinterpret the data.
How a stock trading at a depressed price is frequently
depressed for a very sound structural reason,
a fundamentally negative difference or a permanent
change in the company's financial health or competitive
standing. They screen for cheap and they just
got junk. They bought the value equivalent of
a broken down car. They completely missed Buffett's
refined philosophy. You must have a qualitative
margin of safety. So to address this specific
problem, how to separate the genuinely neglected
value stocks from the cheap, failing ones, a
significant quantitative solution emerged from
academia. And that would be the Piotrowski F
-score. Right. Tell us about that. It was developed
by a Stanford accounting professor, Joseph Piotrowski,
in 2000. The F -score is a rigorous quantitative
tool designed to discriminate between higher
and lower potential members within a class of
already identified value candidates. So you use
it after the initial simple screening. Exactly.
After you've identified stocks with, say, a high
book -to -market ratio. So once you have your
line of cheap stocks, how does the F -score function
to refine it? The F -score is a nine -point scale.
It awards one point for each positive signal
found in a firm's annual financial statements.
And what are those signals looking for? These
nine checks cover three crucial areas of financial
health, profitability, like a positive return
on assets, leverage and liquidity, like a decrease
in leverage, and operating efficiency, like an
increase in asset turnover. So it's basically
a health check focused on whether the cheap company
is improving or deteriorating. Which is vital.
And Piotrowski retrospectively demonstrated the
power of this health check using data from 1976
to 1996. He showed that high F -score selections
within that cheap group increased returns by
7 .5 % annually. Compared to the cheap class
as a whole. Right. That is a massive lift in
performance just by adding a layer of financial
diligence. And its defensive capability was proven
during the global financial crisis. It was. In
a retrospective analysis of 56 different screening
methods applied during the 2008 financial crisis,
the F -score was one of the only strategies that
consistently produced positive results. It's
the perfect systematic answer to that cheap junk
criticism. Now for the final philosophical critique,
which brings this whole deep dive to its head.
And it comes from the man who perfected the strategy.
Warren Buffett's argument that value investing
is, in fact, redundant. This is where the core
logic of investing itself is debated. Buffett
argued passionately in his 1992 letter to shareholders
that defining value investing as a distinct strategy
just causes profound confusion. Why? Because
it suggests that there are other legitimate forms
of investing that aren't based on value. And
what was his conclusion? He argued unequivocally
that growth is always a component in the calculation
of value. Growth is simply the rate at which
the future cash flows of a business will expand.
If you ignore growth, you are miscalculating
value. So if you're truly investing... In this
critique naturally leads to the dismantling of
what he calls naive value schemes. Absolutely.
The problem is when investors take Graham's initial
concept, low PE, high dividend, and apply it
naively, ignoring the fundamental strength of
the business. Take the investor who only screens
for a high dividend yield. Right. They might
prefer a declining company paying a high 5 %
yield over a growing, efficient business that
earns twice as much, reinvest half of that for
20 % growth, and uses share buybacks for tax
-efficient payouts. They're focusing on a simple,
backward -looking... metric and entirely missing
the wealth compounding strength of the growing
business. Exactly. And Buffett critiques that
these naive schemes often lead investors to support
older, highly indebted, technologically uncompetitive
companies. By definition, if you're selecting
stocks based only on those high, simple metrics,
you are frequently missing the great, efficient
businesses that offer the highest long term returns.
Finally, we have to acknowledge the ambiguity
inherent in the process, which is the flip side.
that DCF model. If this is so scientific, why
do two sophisticated analysts reach totally different
conclusions? The critique is valid. The method
of calculating intrinsic value is not perfectly
systematic. As we noted, two analysts can look
at the exact same data and reach different intrinsic
values because they have different assumptions
about growth rates or discount rates in their
DCF models. Which implies there's no single,
systematic, universally agreed upon standard
for valuing every stock. That's right. So success
can't just be measured by the method you use,
but by the result you achieved. The ultimate
measure of success has to be the excess returns
you achieve over the long term after allowing
for all the various risks involved. The market
risk. the specific risks of that industry, and
the idiosyncratic risk of the individual's security.
It just reinforces the idea that investment success
is a combination of disciplined methodology and
superior judgment in assessing quality and risk.
So to wrap up our deep dive, we've taken this
concept of buying a dollar for 50 cents, first
formalized by Benjamin Graham and David Dodd,
and we've traced its powerful evolution across
a century of market cycles. We established that
the foundation rests entirely on the margin of
safety. That critical protective buffer against
uncertainty, analytical error, and market volatility.
Graham insisted on strict quantifiable metrics,
low PE, low PB, low debt, to ensure maximum statistical
cheapness. And we saw how that rigid framework
had to adapt to the modern intangible economy
driven by the profound influence of Charlie Munger
and the refinement of Warren Buffett. They taught
us that true intrinsic value must account for
future growth and durable competitive advantages.
Leading to the mantra, buy a great company. And
whether you lean toward the rigorous, computer
-driven quantitative methods using tools like
the Piotrowski F -score to screen for financial
health, or the qualitative deep -dive methods
of a Buffett or a Klarman, the core mission is
always identical. and acquire the asset below
that calculated figure. That's it. So what does
all this mean for you, the thoughtful investor
who came looking for a shortcut to being well
-informed? It means that the true debate in the
investing world isn't really between value and
growth, as Buffett suggests. That distinction
is largely an artificial construct based on simplistic
metrics. The actual existential conflict in finance
isn't about style. It's about discipline. The
core debate is between discipline analysis, which
is investing, and mere guesswork or emotional
timing, which is speculation. And the sources
show us that truly great growing companies often
look expensive on simple, backward -looking metrics
like P -E or P -B ratios. But because their durable
earnings power is so high and predictable, they
may actually offer the greatest long -term margin
of safety of all. They are the great company
at a fair price. The question for you to mull
over tonight, based on the rigor and the analytical
requirements of these legendary practitioners,
is this. How much reliance do you place on objective
calculation and patience versus hope in short
-term market movements? Which side of that line
investing or speculation does your current approach
truly fall on? Food for thought indeed. Thank
you for joining us for the Deep Dive. We'll see
you next time.