Saturday, 23 February 2013

Origins of value investing

Together with “The intelligent Investor”, the book “Security Analysis” most impacted Warren’s investment philosophy. It was written by Benjamin Graham and David Dodd in 1934, just a few years after the 1929 stock market crash. “Security Analysis” was the first book ever written on value investing and it is still used as a textbook at Warren’s alma mater, the Columbia business school.

Warren eagerly took Dodd’s class, after having carefully studied the book. In fact, he is said to have been able to quote from almost anywhere in it and to even know it better then Dodd himself. He was thus convinced of the validity and applicability of the introduced principles. You can imagine the impact this would have on an author and teacher. Needless to say, that they eventually developed a close personal friendship.

In essence, “Security Analysis” explains how the rough value of a company can be estimated by studying and correctly interpreting its financial statements. This is done by calculating a variety of key figures such as the book value or intrinsic value of a company and then determining the “margin of safety” (difference of intrinsic value and market price). This in turn would determine if any particular stock was worth purchasing. Graham and Dodd had experienced the irrationality of financial markets and realized it presented an opportunity for the patient and rational investor. Anyone serious about learning value investing, is advised to carefully study this book.