Introduction

The value investing approach was developed by Benjamin Graham in the 1920s and 1930s. Graham’s approach to security selecting compares the market price of a security (the most recent price traded on an exchange) to the stock's intrinsic value (the value that a share of stock would be worth if the business were sold in a fair transaction involving a knowledgeable buyer and seller). Studies have shown that value investing historically has had less risk and has outperformed the markets over the long run (past performance does not guarantee future results). 

The Approach

What is value investing? How does it decrease risk? If it’s so good why isn’t everybody doing it? To quote one astute value investor, "A basic premise of value investing is that stocks, like other goods and services should be purchased at the most attractive prices possible, preferably at a discount to their 'intrinsic worth'." The reality for most investors is just the opposite. In other words, investor comfort levels and, therefore, demand increase when prices rise, and diminish as prices decline. The higher the stock rises, the greater the perceived opportunity. 

Value investing, on the other hand, takes a contrary view to this highly emotional process. By systematically reducing risk when others ignore it and taking risk when it is feared, one can capitalize on valuation discrepancies (opportunities) which develop from time to time. The greatest risk that a value investor confronts is the loss of either patience or discipline when faced with the prospect of being out of sync with the market. The value in value investing is to provide a coherent system for rational decision making .... the purpose of which is to compound wealth while minimizing risk. Its basic premise is that the price one pays for an investment makes a significant difference in the return one receives. Therefore value investing challenges the belief that one must take on greater risk to get greater return. 

There are a variety of reasons why value investing is not popular. Value investing is a contrarian style so most managers do not use it since it is easier to defend their position by going with the consensus. Also it is easier for a broker to sell stocks that are hot, such as Internet stocks selling at extraordinary multiples because many investors feel compelled to be part the of excitement. Many times, though, their biggest excitement is the ride down. 

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