Book Review: Value Investing, by Bruce Greenwald, Judd Kahn, Paul Sonkin & Michael van Biema

Good for: analysts, (value) investors, accountants, nerds

Topics: valuation, investing, stocks, competitive advantages

Find it on Amazon, here.

Why I liked it

Value Investing is a great book for anyone that is an investing nerd like me. It is broken into three parts: an intro to value investing; the three sources of value (assets, earnings power value, growth); and the profiles of eight value investors. It is eye-opening and easy to follow, so long as you have a basic understanding of accounting like balance sheets, income, and cash flow statements. I think you will enjoy it far more if you have experience investing in shares or businesses.

What I learned:

Value Investing is an interesting book. Unlike many investment books which teach you the ‘what’ of investing, for example:

  • What to look for in a good business
  • What management of a business should do when XYZ happens
  • And so forth

Value Investing adds to the what by answering the ‘how’.

  • How do you value a good business
  • How do you value a bad business
  • How can you calculate the value of a competitive advantage
  • How do you value a business using only its balance sheet
  • How do you value growth

Only by answering the what with the how can we get to the why and when:

  • Why buy this company now?
  • Why should I sell?

In my opinion, it is this ‘how’ in investing that 90% of investors either do not know or disregard entirely. Most people find it overwhelming and many have other priorities.

Unfortunately, even the pros have other priorities.

For example, let us imagine you are a client of an adviser who you meet with once a month. He is supposed be ‘the’ expert. But the adviser has 100 other clients, so he has no time to research businesses and run valuations on the shares he recommends. He uses someone else’s research.

Ultimately, in investing, it is ‘how’ someone gets to the investment idea that is most important because everyone has an opinion, and anyone can pull up a chart or go to Google Finance for some basic stock information, like dividends.

3 key takeaways

  • The assets. The book shows why good investors value the assets of the business. Basically, start at the top of the balance sheet and work down, putting a price on the assets one by one. Add any assets that might not appear on the balance sheet (e.g. customer contracts). Remove liabilities. Depending on the state of the business and the industry, you will need to apply a different level of scrutiny.
  • Earnings power value (EPV). The EPV is the value of the company’s normal profits. You might think: profits are profits — that’s the value, right? Wrong. We use the profits to arrive at a value for the entire company. The formula is adjusted profits x (1/R). R is the cost of capital. If you’re confused, don’t worry, I’ll cover all of this and more in our new valuation course, which is free of course.
    But here is the interesting part about this: if the EPV figure is materially larger than the value of the assets, the difference is the value of the franchise. In other words, your company’s competitive advantage. “That’s that thingo Warren Buffett always talks about!” I hear you say.
  • Growth. The only time growth has any value to shareholders — yes, the only time — is if the EPV is consistently above the value of the assets. That’s because growth in the ‘franchise’ (i.e. in markets/products where the company has a competitive advantage over its rivals) is the only place it can grow economically. Outside of that, the costs overwhelm the benefits, even if it does not appear that way initially!

Please note: these are the views expressed in the book. My views differ slightly, which I have expressed elsewhere.

Once again, I’ll cover these techniques in detail in our new valuation course, which is a free video series in which you will look ‘over-the-shoulder’ as I work through these valuation techniques step-by-step. Ultimately, you will be able to value any investment for yourself.

All in all, a great book for value investors!

P.s. here’s my complete reading list.