Is Knowledge or Application More Important?


I tout myself as a value investor and although there are many variations to the rules of value investing, the basic tenants are the same. We all know what we should be doing, but doing it is another thing.
Knowing some of the error traps associated with value (defensive) investing allows for a plan of action to avoid them. Here are some suggestions that have helped me from time to time:


Written by

Dustin Allen

I heard the other day that 85% of Americans own running shoes but only about 15% of them regularly run.

We all know what we should be doing, but doing it is another thing.

The same is true when it comes to investing.

I tout myself as a value investor and although there are many variations to the rules of value investing, the basic tenants are the same.

Pursue Only Fundamentally Sound Companies

This easily quantifiable and emotionless step is usually taken care of with a stock screener.

I look at current ratio, earnings growth, earnings stability, dividend record and price to book. If a company can make it past my screen, a quick look at the last ten years statements will verify the condition of the financials.

Purchase Companies at a Price Below or at Fair Value

Here is where it can start to get a little tricky.

Fair value is usually determined by estimating future earnings and multiplying them by a capitalization factor. This requires research of past performance, long term prospects and company management; usually done by reviewing several years’ worth of 10K filings.

Two things become a problem here.

  • First, it should go without saying that ‘estimating the future’ of anything is really nothing more than an educated guess.
  • Second, the more time spent researching a company and its statements an emotional bond may develop.

Once an estimate of earnings and capitalization has been made, these numbers are usually plugged into a formula, e.g. the Graham formula of Value = Earnings (8.5+ (2g)) to get the fair value result.

But what if the number is not what was expected or desired?

Suddenly you are emotional. Maybe you feel like you wasted all that time reviewing the company; maybe you really like the company now after learning more about it.

This is the dangerous path that may lead to manipulating the numbers to reach a desired value.

Plan and Invest with a Long Term Horizon in Mind

Long-term can become short-term with gains and losses.

Scenario 1: The Company you bought at a bargain has now become an even bigger bargain. Doubt creeps in, conviction wavers. Three choices present themselves at this time; ride it out – sell and take what is left – or strengthen the position.

Scenario 2: The Company you bought at a bargain has now become an overnight sensation. This scenario has its pitfalls too. Is it time to take profits now or let it ride until your long-term timeline? It all depends on how much confidence you have in the estimation of value and future prospects of the company.

“Knowing is Half the Battle!” – G.I. Joe

Again, we all know what we should be doing, but doing it is another thing.

Knowing some of the error traps associated with value (defensive) investing allows for a plan of action to avoid them. Here are some suggestions that have helped me from time to time:

  • Read and re-read the guiding principles and authors. I have a dog-eared copy of The Intelligent Investor handy for when things get slow. This helps to strengthen my resolution and keeps me out of my portfolio.
  • Distance yourself. Warren Buffet said for years, that part of his success was because Omaha is a long way from Wall Street. I am pretty far from Wall Street myself, but only if I turn off the television and computer. Sometimes, that is exactly what I have to do.
  • Take the time to develop your own guidelines and goals for investment. Every successful company has a mission statement, so why don’t you?
  • Keep your eye on the prize. That long-term horizon can be hard to see sometimes. Visualize the future and reaching the goals you have set. This can make the short-term easier to bear.

“A strong minded approach to investment, firmly based on the margin-of-safety principle, can yield handsome rewards. But a decision to try for these emoluments rather than for the assured fruits of defensive investment should not be made without much self-examination” – Benjamin Graham

Value investing is hard; not the concept, but the application.

  • Excellent. Application takes a whole new set of emotional muscles (as you clearly state).

    Here are a few things that help for me.

    I like to slow down the visuals. Looking at weekly 1 year and 5 year charts help. Monthly charts and intra-day charts don’t help.

    I like to have my greatest misses handy. I have to remind myself that I was right (once or twice) before, and if I react I could jeopardize ‘the plan’.

    I also like to keep charts handy that represent stocks that have ‘turned the corner’. Corning and Alaska Airlines come to mind.

    These things quells the internal strife, but on big down days when conviction is in question then I really have to reach for a safe place in my mind. Rabbits feet, charms, idols, high balls of Canadian Whiskey and Ice… Well you get the picture.

  • Good article Dustin. I wrote a little while back how I slowed down my activity and anxiety by reading through Buffett’s partnership letters. A lot of the content was repetitive and I think that is what helped me. It kept hammering home the message of how I shouldn’t be concerned about the market.
    It has been about 3 weeks since I accidentally deleted my portfolio on G Finance and it’s amazing the different mindset you get. I no longer look at how my stocks are performing whenever I visit G Finance and can stick to focusing on the company that I am interested in.

    Frank has made some good points too.

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