Value investing is an investment strategy where stocks are selected that trade for less than their intrinsic values. Value investors actively seek stocks they believe the market has undervalued. Investors who use this strategy believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with a company’s long-term fundamentals, giving an opportunity to profit when the price is deflated.
Benjamin Graham is often seen as the father of Value Investing and he greatly influenced Warren Buffett’s investment philosophies.
Recently I have come across a book The Four Filters Invention of Warren Buffett & Charlie Munger by Bud Labitan and he has effectively sort of “condensed” the principles of value investing by Warren Buffett and Charlie Munger into a “Four Filters” investment process. When Warren Buffett and Charlie Munger talk about how they make investment decisions, they will usually cite these considerations (or filters) as the fundamental guiding principles.
May be stated using different words, but these four filters are:
1. Do You Understand The Business?
Before you invest in a particular stock, do you understand the business? This relates to your circle of competence, whether if you have understanding of a particular company and industry because of your interests, job experience, exposure, consumption behavior etc. In other words, you have some inherent knowledge which makes it easier for you to understand the company, its business environment, customers, suppliers, technology and competitive landscape.
This all comes in handy when you make judgement about the future of the company, whether it is going to continue to thrive, whether earnings will be maintained and what possible disruptions there will be to the industry the company is in etc.
If it is too hard to understand, Warren Buffett and Charlie Munger will not explore further. For a long time, they have not invested into technology stocks (because it was too hard for them to understand) until a huge stake invested into Apple recently.
2. Does The Company Have A Sustainable Competitive Advantage
This is also commonly referred to as economic moat as coined by Warren Buffett. The concept of competition is that when a business is doing well, and it is getting good earnings, there will be other players (new entrants who will become competitors) motivated to join the fray.
A company having a sustainable competitive advantage means the company possesses some barriers of entry, making it difficult for the competitors to come into the market, steal away the customers and erode the revenue and earnings.
A company having a strong economic moat will thrive for a long time with good profits.
3. Does The Company Have Able And Trustworthy Managers
Warren Buffett and Charlie Munger are also very particular about whether a company is run by a good management team. In particular, they pay attention to whether the managers care about themselves more or are more concerned about the company performance, servicing customers well and delivering good products and services.
When there is a good management team, Warren Buffett typically gives them full autonomy to run the business operations without interference and operational control.
4. Is The Business Available At A Bargain Price
This filter relates to the belief that Mr Market sometimes provides to value investors the opportunities to buy the shares in companies below their intrinsic values. The difference between the intrinsic value and the market price is the margin of safety.
There are of course various valuation techniques such as PEG, discounted cash-flow etc but the point is that all valuations are probably not exact, so the margin of safety allows you some margin of error such that you are buying companies which pass the other 3 filters at a big enough discount.
The book is very readable and serves as a very good succinct summary of the essence of the value investing principles which Warren Buffett and Charlie Munger have used to much success. There are also check-lists provided for management evaluation etc. You can check out both the physical book and the e-book on Amazon.
I also have permission from the author Bud Labitan to share a video he has put together, essentially that of Warren Buffett and Charlier Munger talking about these principles from different settings and events.
The Value Investing Bootcamp is where you can learn these principles, coupled with the valuation techniques and the fundamental analysis. Attend the preview workshop to find out more and at the same time, pick up Options knowledge so you can use in conjunction with stock investing knowledge to build up your passive income.
If you would like to read more about value investing, below are some books that we recommend: