Value investors are a curious breed. They propagate the idea that when something falls in price, it becomes less risky. If one reads the value investing texts or listens to the brethren, the idea that at some price, all risks are priced in; is followed as gospel to make money.
Buying something for less than it’s worth is the holy grail of value investing. This is a simple idea and like most simple ideas in the world, it’s not easy.
If someone was to sell me a new Mercedes Benz S Class for 10 Lakhs, I will go and borrow money to buy it. I know that it’s worth a lot more because if I were to buy it directly from the company, I’ll pay a lot more.
This is a good deal. Why? Because there is certainty involved. I know the car is worth way more, with certainty. If I bought the car at 10 Lakhs and the CEO was to resign tomorrow admitting that there was manipulation in the company’s accounts for the last 5 years, it will make no difference to me. My shiny new car will still be out there having improved my social status by leaps and bounds.
Now, say I bought Mercedes Benz stock at a similar discount and the CEO resigned with an accounting scandal on hand, my stock won’t be worth much, would it?
Buying stocks is not like buying other products. We are not buying certainty. There are no warranties or after sales service. We are buying probable outcomes and we should try and pay for them accordingly.
To say that I will buy something for less than it is worth is easy. It’s super difficult to know what something is truly worth and then buying it at a much lower price is even more so. In most cases, we cannot determine the true worth as we have no idea about the probable outcomes because we don’t have the experience or the knowledge to understand the risks.
For the few that we do, there will still be risks that remain hidden for long periods of time. Questions like – what if there is something that I don’t know that others do – will pop up. What about unknowables? What if a high debt company, with a lien on their only plant, has a fire at a time when its insurer too goes belly up?
Even after all this, it’s not just this analysis of value and risks that’s enough. We need one more thing: boldness. To say that I as a buyer know more than the seller in itself shows hubris. Still, one needs some of it, this boldness, to make it in this business.
We talk about being humble but the act of buying involves boldness. We walk the tight rope made of humility and boldness. Bold enough to say yes to something and humble enough to know that we might be wrong. It’s simple, not easy!
Why be a value investor at all then?
The whole world is uncertain. There is no guarantee that you will wake up tomorrow. Only a high probability. Value investors bet on high probability events while understanding that certainty comes at a price. Thus, we look for slight uncertainty along with very low prices.
Knowing this, it doesn’t sound like an attractive vocation, does it? Well, there are two kinds of people in the world. Ones who like the certainty and meekness of FDs and ones who like the uncertainty and boldness of equities and if history is any indication, the latter will do better financially.
Successful value investors have made money in leaps and bounds. Because there is one interesting truth about humanity: concentrated effort often leads to high rewards. Same is true for businesses and value investors try to own such businesses and enjoy the rewards.