Price on Value
September, 1999

John Price,  Ph.D.

Two dogs are sitting beside the road watching a third dog chasing a car. The first dog says to the second, "He wouldn’t know what to do with it if he caught it."

It is a similar story with many investors. They might catch their stocks. But because they were never sure of why they were after them in the first place, they don’t know what to do next.

In The Three Golden Rules of Investing I gave the following as the second rule: Know why you are buying a particular stock—don’t wait until its price goes up or down to think about it.

"When you know why you bought Intel, for example, you will have a stronger basis for knowing what to do when its price goes up, or down, or even stays the same," I continued. "For instance, if Intel starts to go down in price and you bought it as a momentum play, then you will probably want to sell as quickly as possible. But if you bought it as an undervalued stock, and if the fundamentals have not changed, then you might want to buy more."

Of course, every investor and every stock presents a different reason for contacting your broker. But we have to start somewhere so here is my analysis of the six main investment styles.

Brother-in-law investor Your brother-in-law phones, or perhaps your stockbroker or the investment writer for the regional newspaper. He has the scoop on a great stock but you will have to act quickly. If you are likely to buy in this situation, then you are a "brother-in-law investor." Brother-in-law investors rely on the advice of other people to make their decisions.

Technical investor Moving averages, candlestick patterns, Gann charts and resistance levels are the sort of things the technical investor deals with. Technical investors were once called chartists because their central activity was making and studying charts of stock prices. Nowadays this is usually done on a computer where advanced mathematics combines with grunt power to unlock past patterns and correlations. The hope is that they will carry into the future.

Economist investor This type of investor bases his decisions on forecasts of economic parameters. A typical statement is "The dollar will strengthen over the next six months, unemployment will decrease, interest rates will climb—a great time to get into bank stocks."

Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.

Fisher also suggests that useful information can be obtained from vendors, customers, research scientists and executives of trade associations.

Value Investor In the fourth edition of the investment classic Security Analysis, the authors Benjamin Graham, David Dodd and Sydney Cottle speak of the "attempts to value a stock independently of its current market price". This independent value has many names such as ‘intrinsic value,’ ‘investment value,’ ‘reasonable value,’ ‘fair value’ and ‘appraised value.’ They go on to say:

A general definition of intrinsic value would be "that value which is justified by the facts, e.g., assets, earnings, dividends, [and] definite prospects, including the factor of management." The primary objective in using the adjective "intrinsic" is to emphasize the distinction between value and current market price, but not to invest this "value" with an aura of permanence.

Value investing is the name given to the method of deciding on individual investments on the basis of their intrinsic value as contrasted with their market price.

This, however, is not the standard definition. Most authors refer to value investing as the process of searching for stocks with attributes such as a low ratio of price to book value or a low price-earnings ratio. In contrast, stocks with high price to book value or a high price-earnings ratio are called growth stocks. Investors searching for stocks from within this universe of stocks are called growth investors. These two approaches are usually seen to be in opposition.

Not so, declared Warren Buffett. In the 1992 Annual Report of Berkshire Hathaway he wrote, "the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive."

There is another type of investor that overlaps the six types just mentioned. I call this type the:

Conscious Investor Increasingly investors are respecting their own beliefs and values when making investment decisions. For many, quarterly earnings are no longer enough. For example, so many people are investing in socially responsible mutual funds that the total investment is now over one trillion dollars. Many others are following their own paths to clarify their investment values and act on them. The process of bringing as much honesty as possible into investment decisions we call conscious investing.

Most people invest for different reasons at different times. Also they don’t fall neatly into a single category. In 1969 Buffett described himself as 85 percent Benjamin Graham [Value] and 15 percent Fisher [Scuttlebutt].

Whatever approach, or approaches, you take, the most important thing is know why you bought a particular stock. If you bought a stock on the recommendation of your neighbor, be happy about it and recognize that this is why you bought it. Then you will be more likely to avoid the "investor imperative": If your stock rises, claim it as your ability, if it falls, pass on the blame.

Following the investor imperative, if you buy a stock and it goes up in price, you proclaim it as the result of your analysis skills, or your infallible intuition, or some other desirable ability. If it goes down in price, you blame it on the stockmarket or the economy or the fact that S&P500 has declined. Anything but your fault.

Do all that you can to avoid going down this path. Write down why you bought a stock. Tell your spouse your reasons. Tape them on your bathroom mirror. Above all, if you want to be a successful investor, don’t kid yourself.

You can get more information about the above topic and the Valuesoft Investment System on my web site http://www.sherlockinvesting.com. Next month’s article "The Three 'Little' Words of Investing" will discuss the three words that are the basis of long-term investing.