Value Investing by Bruce C. N. Greenwald, Judd Kahn, Paul D. Sonkin, Michael van Biema see larger photo List Price: $19.95 Our Price: $13.57 Released 09 January, 2004 Paperback Availability: Usually ships in 24 hours

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Customer Review
high marks from a macro guy
4/5 Stars
The back cover bills this book as `a must read for all disciples of value investing.'

I am most definitely NOT a disciple of value investing - nor a value investor in any real sense - yet I found the book valuable. Greenwald and company do an excellent job in distilling the essence of value investing, giving an objective sense of what it is and how it's done. The picture they paint is clear and structured, yet flexible enough to cover the various manifestations of value investing out there.

If you view the market as a sort of investment ecosystem, with multiple survival strategies in use - all of them interacting and influencing one another - then you naturally want to have an understanding of the strategies out there besides your own. In this sense, the mindset of the value investor is as interesting as the specific analytical tools he or she uses. And given the countless billions devoted to value, these guys leave an `ecological footprint' that can't be ignored.

It's also interesting to note that value investing is far from simple and far from easy. As the book notes, Graham's treasured `net-net' situations have all but disappeared, except in cases where the company is on the brink of collapse or destined for slow demise. Furthermore, value investors profess to be `bottom up' rather than `top down,' and are actively disdainful of macro analysis on the whole... yet calculating `cost of capital,' a key element of valuation, is very much a macro exercise! To properly value the cash flow stream in question, you must benchmark it against the comparative risk-adjusted return, or `cost of capital,' demanded by investors. But to know what general level of return will be demanded by investors - i.e. to know the cost of capital -- you will need to have a feel for interest rates, risk appetite, appeal of alternative asset classes, general propensity for valuations to expand or compress within the given time period, and so on. In otherwords, macro stuff.

I found it ironic that such a basic tool of microfundamentalists - discounted cash flow - turns out to be so macro-dependent. To their credit, Greenwald & co. take this deficiency head on: "We should be struck here by a glaring inconsistency between the precision of the algebra and the gross uncertainties infecting the variables that define the model." No kidding! They go on to note that `terminal value', in most cases the largest determination of net present value, can vary by huge margins in either direction based on small adjustments to initial input. In other words, a small fudge in your NPV calculation can steer you hundreds of miles off course. But perhaps this is where the "margin of safety" comes in... value investors prefer plenty of elbow room to account for potential gigantic holes in their calculations, as well as hit-or-miss timing.

After highlighting the follies of NPV, the book introduces Graham and Dodd's alternative methodology. In essence, G&D place much more emphasis on the certain present relative to the uncertain future. This creates issues of its own, however: For example, how do you value the intangible assets of an innovation-based company in a knowledge-based economy? How do you value things like strategic relationships and branding? How do you account for political risk, technological risk, demographic risk, etc? Perhaps the short answer is: as a strict value investor, you don't. You stick to your knitting and ignore the stuff that can't be nailed down. And yet, that answer doesn't really fly, because one of the things Graham and Dodd consider is the `franchise value'... which certainly can't be nailed down, is tough to account for on a balance sheet, and is subject to substantial change over time given ever-shifting landscapes.

The point here isn't to suggest value investing is inherently flawed. Rather, it's to point out that successful value investors are much more than pure number crunchers. To do it right, they have to get into a lot of those nebulous, gray areas that dilute the purity of the discipline. `Dollar bills for fifty cents' just ain't that easy, and cheap is only good in the right context. I also had to wonder, how much of value investing is really just long range timing based on market cycles. Meaning take your shots occasionally, but mostly wait for those once-in-a-decade opportunities to load up on good assets marked down heavily, when Mr. Market is on Prozac, Xanax and Lexipro all at once.

Objections aside, the value method can work well for its disciples. It just isn't the be-all-end-all that some make it out to be... there are many paths up the mountain, and value investing is but one of them. (Funny how the followers of feted disciplines often look down on or belittle the other paths, seeing their way as the "only" way. But that's actually a credit to this book, as Greenwald recognizes and acknowledges there are other paths that work.)

The second half of the book (a profile of eight value investors) was entertaining and informative, a cross-section of the value investing mindset in application. The section on Buffett got me thinking about his money troubles - that is, the trouble with investing $40 billion - and how Buffett's size issues reflect on the discipline of value investing as a whole. Could Berkshire Hathaway itself be overplayed? When a company reaches its peak valuation in the fullness of time, a disciplined value investor cashes out at least some, if not all, of their position. Can the Oracle of Omaha apply the same discipline to his own shop?

In the world of commodities trading, the biggest CTAs (Commodity Trading Advisors) are trend followers, with tens of billions under management. Trend following is a wholly different strategy than value investing, with an entirely different niche in the ecosystem, and yet the big problem faced by trendfollowers and value investors is the same. That problem is: when there are too many others pursuing your strategy, the level of returns will erode until enough players are shaken out to make the strategy profitable again.

Greenwald believes that value opportunities will always persist, and gives a number of reasons why institutions and large fund managers will continue to overlook value based opportunities. But he doesn't mention the proliferation of hedge funds which, in spite of bad press, is likely to only increase over the years. Rather than a top heavy institutional model, perhaps we will ultimately see a much larger number of private money managers, with small funds in the tens of millions rather than large ones in the hundreds of millions or billions. And these guys will have no problem going against conventional Wall Street wisdom in pursuit of superior returns... making the value world that much more competitive, and good values that much harder to find.

In conclusion, I'm not sure how well this book plays with experienced value investors (as I am not one of them). But if you're new to value, or experienced in a different discipline and curious as to how the value guys think, I can definitely give it an enthusiastic thumbs up.

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