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PART ONE

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Warren Buffett On Gold


This is part one of a ten part series on some of the most important and educational literature for investors with a
focus on value. Across this ten-part series, Im going to take a look at ten academic studies and research papers from
some of the worlds most prominent value investors and fund managers.
All of the material can be found under the Timeless Reading tab at ValueWalk.com. And if you dont know where
to start, weve put together a Value Investors Must Read List of resources, which once again can be found under the
Timeless Reading tab.
To start this series, Im taking a look at an article published in Fortune during February 2012 and penned by Warren
Buffett titled: Why stocks beat gold and bonds. The article, which can be found here, and is now archived on theDavis Funds website, is more than just an insight into Warren Buffetts thoughts on gold. Indeed, the article draws a
line between the two different disciplines of investment and speculation.
Warren Buffett begins:
Investing is often described as the process of laying out money now in the expectation of
receiving more money in the future. At Berkshire Hathaway Inc. we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned
expectation of receiving more purchasing power -- after taxes have been paid on nominal gains
-- in the future. More succinctly, investing is forgoing consumption now in order to have the
ability to consume more at a later date. -- Warren Buffett
Warren Buffett goes on to say that at Berkshire, the riskiness of an investment is not measured in the traditional Wall
Street way of beta, but rather by probability -- the reasoned probability that the investment will cause permanent
capital loss to the investor. This is a crucial factor. Investments can fluctuate in price are not always risky, while some
investments that are considered risk-free, because their prices do not fluctuate on a day-to-day basis, can be laden with
risk.
Buffett believes that there are three main investment categories.

Warren Buffett: Risky currency


Firstly, safe Investments denominated in any given currency can be inherently risky. These include
mortgages, money-market funds, bonds and bank deposits. Governments ultimately control the value of money and occasionally policies designed to control or stimulate inflation get out of control.
Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire...Consequently, a
tax-free institution would have needed 4.3% interest annually from bond investments over that
period to simply maintain its purchasing power.
For tax paying investors...the picture has been far worse. During the same 47-year period,

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continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory.
But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7%
return would have yielded nothing in the way of real income. -- Warren Buffett
Income tax paying investors would have seen 1.4 points of yield taken away by tax and a further 4.3 points in inflation.
As a result of these dismal figures, Buffett and Berkshire will only purchase currency-related securities if theres the
possibility of an unusual gain. The most common situations are credit asset mispricings or because rates rise to a level
that offers the possibility of realizing substantial capital gains when rates fall.
Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt:
Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.
-- Warren Buffett

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Assets that will never produce anything
The second category of assets, which seem to be safe investments at first glance but are in fact inherently risky, are,
according to Warren Buffett:
...assets that will never produce anything, but that are purchased in the buyers hope that
someone else -- who also knows that the assets will be forever unproductive -- will pay
more for them in the future. -- Warren Buffett
Tulips are of course the most famous of this asset class. Buffett continues:
This type of investment requires an expanding pool of buyers, who, in turn, are enticed
because they believe the buying pool will expand still further. Owners are not inspired by
what the asset itself can produce -- it will remain lifeless forever -- but rather by the belief
that others will desire it more avidly in the future. -- Warren Buffett
This is where Buffett begins to criticize gold as an investment. It is the favorite bastion of safety for investors who are
afraid to hold almost all other assets. However, golds most pressing shortcoming is the fact that it does not grow. If
you buy one ounce of gold and hold it for eternity, at the end, youll still be holding one ounce of gold.
In his article, Buffett goes so far as to state that gold was in a bubble, similar to the dot-com or housing bubbles, at the
time the article was written Feb 9, 2012, gold was trading around $1,750). The Oracle of Omaha then uses an example
to lay out why investors should avoid gold as an investment.
Today the worlds gold stock is about 170,000 metric tons. If all of this gold were melded
together, its...value would be about $9.6 trillion. Call this cube pile A.
Lets create a pile B costing an equal amount. For that, we could buy all U.S. cropland...
plus 16 ExxonMobils...After these purchases, we would have about $1 trillion left over
A century from now the 400 million acres of farmland will have produced staggering
amounts of corn, wheat, cotton, and other crops...ExxonMobil (s) will probably have delivered trillions of dollar in dividends to its owners and will also hold assets worth many
more trillions...The 170,000 tons of gold will be unchanged in size and still incapable of
producing anything. You can fondle the cube, but it will not respond.

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These figures are somewhat out of date, but you get the picture.

Productive assets
Buffetts third and final investment category is that of investments in productive assets, whether it be businesses,
farms or real estate. Buffett likes assets that can deliver an increase in real purchasing power over the long-term, while
requiring a minimum of new capital investment. Companies such as Coca-Cola, International Business Machines
Corp., and Sees Candy.
I believe that over any extended period of time this category of investing will prove to be the runaway winner among
the three weve examined. More important, it will be by far the safest.
________________________________________

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PART TWO

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What Has Worked In Investing


What has worked in investing?
Part two of this series is devoted to a research booklet published by Tweedy, Browne Company LLC. Tweedy, Browne
has become synonymous with value investing over the years. Founded in 1920, Benjamin Graham was one of the
firms primary brokerage clients in the 1930s, 1940s, and 1950s. Then during 1959 the partners of Tweedy, Browne
and Tom Knapp (who had joined from the Graham-Newman) pooled their capital in a partnership investment vehicle. You can read more about Tom Knapp at ValueWalks exclusive Tom Knapp Resource Page.
Tweedy, Brownes booklet, What Has Worked In Investing groups together several studies of investment approaches and characteristics associated with exceptional returns. The booklet begins:
Dear Investor:
What Has Worked in Investing is an attempt to share with you our knowledge of historically
successful investment characteristics and approaches. Included in this booklet are descriptions
of over 50 studies, approximately half of which relate to non-U.S. stocks. Our choice of studies has not been selective; we merely included most of the major studies we have seen through
the years. Interestingly, geography had no influence on the basic conclusion that stocks possessing the characteristics described in this booklet provided the best returns over long periods
of time. While this conclusion comes as no surprise to us, it does provide empirical evidence
that Benjamin Grahams principles of investing, first described in 1934 in his book, Security
Analysis, continue to serve investors well.
But with over 50 studies to cover, published across 60 page, I can only scratch the surface of the data gathered together within What Has Worked In Investing. So, to try and condense as much information into this one article
as possible, Im going to look at one random study from each of the study groups in the booklet. Studies of returns
generated through different strategies are grouped into six categories:
1.
2.
3.
4.
buying
5.
6.

Assets bought cheap


Earnings bought cheap
Stocks with high dividend yields
Investing with the inner circle: buying stocks where the insiders (officers, directors or the company itself) are
Stocks that have declined in price
Stocks with smaller market capitalizations.

What has worked in investing: Assets bought cheap


The most famous Assets bought cheap strategy is Benjamin Grahams Net Current Asset Value Stock Selection
Criterion.
Another study, Are Low Price-to-Book Value Stocks Higher Returns, as Compared to High Price-to Book Value
Stocks, due to Higher Risk? attempted to assess the riskiness of using a deep value. Professors Lakonishok, Vishny
and Shleifer measured monthly investment returns in relation to price as a percentage of book value between April
30, 1968 and April 30, 1990. They found that the low price-to-book value stocks outperformed the high price-to(C)
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book value stocks in the markets worst 25 months, and in the other 88 months when the market declined. And
concluded:
Overall, the value strategy [low price-to-book value] appears to do somewhat better than the
glamor strategy [high price-to-book value] in all states and significantly better in some states.
If anything, the superior performance of the value strategy is skewed toward negative return
months rather than positive return months. The evidence [in Table 9] thus shows that the value
strategy does not expose investors to greater downside risk.

What has worked in investing: Low price to book value

What has worked in investing: Earnings bought cheap


One of the most interesting studies in the Earnings bought cheap section of the booklet is The Performance of
Value Portfolios Versus Growth Portfolios Revisited through 2001. An article titled Value and Growth Investing:
Review and Update, published within the Financial Analysts Journal, Vol. 60, No. 1, pp. 71-86, January/February
2004 Louis K.C. Chan and Josef Lakonishok reviewed the performance of growth and value strategies through
2001. They found that even after taking into account the experience of the technology led stock markets of the late
1990s,value stocks generated superior returns. They further concluded that common measures of risk do not support
the argument that the return differential is a result of the higher riskiness of value stocks, but rather, in their opinion,
is due to behavioral considerations and the agency costs of delegated investment management.

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What has worked in investing: Stocks with high dividend yields


The study, High Dividend Yield Stocks Generally Outperform Those with Lower Yields, However, the Best Returns
Have Not Come from those with the Highest Yields. Higher Yields Coupled with Low Payout Ratios Have Produced
the Best Returns published by Credit Suisse Group Quantitative Equity Research, August 15, 2006 found a direct
correlation between low payout ratios and higher returns in the dividend universe.
The researchers ran a simulation of a dividend strategy from January 1980 to June 2006 creating equal weighted decile
baskets based on dividend yields as of each month-end. They found that stocks with higher dividend yields generally
outperformed those with low dividend yields, but the highest yield decile did not produce the best overall return.
The researchers then created three dividend yield baskets ranked by yield; i.e., high yield, low yield and no yield. Then,
within each of these baskets they categorize stocks based on payout ratio; i.e., high, medium and low. In this study, the
basket with the highest yields combined with low payout ratios produced the best returns. The high yield, low payout
portfolio bucket generated an annualized return for the period of 19.2% versus 11.16% for the S&P 500.

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What has worked in investing: Investing with the inner circle: buying stocks where the insiders
(officers, directors or the company itself) are buying
Tweedy, Browne uses this section of the booklet to group together five different studies, all of which assess the
impact of insider accumulation of stock price performance. The five studies, Donald T. Rogoff, The Forecasting
Properties of Insider Transactions, Diss., Michigan State University, 1964; Gary S. Glass, Extensive Insider Accumulation as an Indicator of Near Term Stock Price Performance, Diss., Ohio State University, 1966; Charles W.
Devere, Jr., Relationship Between Insider Trading and Future Performance of NYSE Common Stocks 1960 - 1965,
Diss., Portland State College, 1968; Jeffrey F.Jaffe, Special Information and Insider Trading, Journal of Business,
July 1974; and Martin E. Zweig, Canny Insiders: Their Transactions Give a Clue to Market Performance, Barrons,
July 21, 1976, cover a period from 1958 to 1976 and show that the investment returns on the stocks of companies
purchased shortly after insiders purchases all surpassed the subsequent market performance.

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What has worked in investing: Stocks that have declined in price


In a study entitled, Does the Stock Market Overreact?, published in The Journal of Finance, July 1985, Werner F.M.
DeBondt and Richard Thaler, Professors at the University of Wisconsin and Cornell University examined the investment performance of stocks with the worst and best prior investment results. The professors looked at the returns
of stocks from 1932 through to 1977. Taking the prices of the 35 worst performing and 35 best performing stocks
over the preceding five years on 31 December every year, the results showed that the worst performing stocks over
the preceding five-year period produced a compound annual return in excess of the market index of 12.2%. The best
performing stocks over the preceding five years produced a compounded annual negative return of -4.3% versus the
market index.
Jeremy Grantham, the founder of GMO LLC, believes that buying the markets dogs is the best way to outperform
over time. Jeremy Grantham: The Man Who Loves Dogs 1978 Barrons Interview.

What has worked in investing: Stocks with smaller market capitalizations


The final section of Tweedy, Brownes book looks at the performance of stocks with smaller market capitalizations
over time. Here, the most interesting study comes from The Journal of Portfolio Management, Winter 1983. Conducted by Marc Reinganum, the study titled, Portfolio Strategies Based on Market Capitalization, studied the investment returns of all stocks listed on the NYSE and AMEX from 1963 through 1980. Stocks were sorted into deciles
and ranked according to market capitalization.
The results of this study showed that over the period, the smallest market cap companies (average market cap. $4.6
million) produced an average annual return of 32.8%, while the largest market cap companies (average market cap
$1.1 billion) produced an average annual return of only 9.5%. Bigger isnt necessarily better.

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PART THREE

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Behavioral Investing
James Montier is the author of several books that have become staples for any investor, one of which is Behavioral
Investing: A Practitioners Guide to Applying Behavioral Finance. Within the pages of the book, James Montier summaries the topic of behavioral investing -- a broad topic with an enormous amount of research available. Additionally,
James Montier adds some insights of his own on the topic, making the book an indispensable resource for investors
on the subject of behavioral finance.
The Brandes Institute, the research arm of Brandes Investment Partners has put together a summary of James Montiers book, with some added insights. And its this summarized six-page booklet that Im looking at within this article.

Brandes on behavioral investing


James Montier starts his book by describing how the brain works. The brain has two main information processing systems; the reflexive and the reflective. The brain defaults naturally to the emotional or reflexive system, as opposed to
the objective, or reflective system. It may surprise you to know that reflective thinking is tiring. The brain is a muscle,
and when used for a long period it becomes fatigued. Brain fatigue can, and does, affect performance.
Unfortunately, there are two human qualities that complicate decision-making. Firstly, the brain is hardwired to enjoy
short-term gratification. Secondly, the brain dislikes social-exclusion behavior (the brain prefers a herd mentality).
Whats more, according to James Montier, the brain is also susceptible to 22 other forms of bias. The majority of
these biases revolve around self-deception, simplification, emotion and social interaction. The Brandes Institute researchers picked out eleven key emotional biases that they believe are the most damaging to investor performance
over the long run.
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The first four key criteria relate to the central bias of self-deception. Two of these are overconfidence and overoptimism. More often than not, investors overestimate their ability and feel more confident than they should. Two other
self-deception factors are self-attribution and hindsight. Simply put, people credit their skill for good outcomes and
blame bad luck for bad outcomes.
On the central topic of simplification, once again there are four primary traits that hold investors back. Firstly, anchoring: People often grasp non-relevant information, often believing that are making better decisions. Secondly, representativeness: People judge by appearance rather than likelihood. People like a good story over hard facts. Thirdly,
framing: More often than not, investors will give different answers depending on the same, but differently framed,
questions. Fourth, loss aversion: People usually give more weight to losses than to corresponding gains.
On the two central topics of emotional and social interaction, James Montier notes that the two main traits holding
investors back are:
1.
Regret theory: The fear of being wrong outweighs the cost in objective economic
terms
2.
Herding: Neurologists have found that real pain and social pain are felt in the same part
of the brain. Contrarian strategies are the investment equivalent of seeking out social pain.
James Montier pulls together all 22 behavioral biases and four central topics to create a Seven Sins of money management:
1. Enormous evidence shows investors are hopeless at forecasting, yet it may be at the heart
of their investment process
2. Investors are obsessed with information, yet more information doesnt lead to better decisions, just overconfidence
3. Meetings with company management are overrated; management themselves are likely highly biased.
4. Investors typically think they can outsmart everyone else.
5. Investors are increasingly obsessed with short-term time horizons
6. People like good stories and often enhance them to suit their own biases, while ignoring the
boring facts.
7. The minds default tendency is to believe; innate skepticism is rare, yet advantageous in investing.
But behind almost all behavioral biases is group behavior. James Montier believes that the subject of group behavior
is one of the most important in behavioral finance. Psychologists have found that groups amplify rather than alleviate decision-making biases. They falsely lead members to increased confidence and are not good at uncovering new
information.
Groups can suffer cascades (in which individuals abandon their own views), polarization (in
which groups move to a more extreme version of original beliefs), and ultimately groupthink
(an extreme version of polarization).
Behaviorists distinguish between statistical groups, whose independent decisions actually add
up to pretty good decisions, and deliberative groups, who tend to amplify biases. Group biases include the main ones noted previously: representativeness, framing, overconfidence, and
anchoring. Montier notes that solutions to the problems of group decision making are just as
difficult as overcoming individual biases. Possible solutions include: secret ballots, devils advocates, and simply having respect for other group members.
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Behavioral Investing - Fallacies in modern finance theory


In his book, behavioral investing: a practitioners guide to applying behavioral finance James Montier also weighs in on
fallacies in modern finance theory. Montier attacks three tenets of classical finance: beta and the limitations of CAPM,
the risk in value vs. growth stocks, and reliability of alpha and beta calculations. The key argument behind Montiers
attack on these principles is that, using both US and international data, value stocks have traditionally exhibited lower
volatility and higher returns while growth stocks have had higher volatility and lower returns. This is the antithesis of
CAPM, which is built on the thesis that risk and return go hand in hand. For a further deconstruction of the CAPM
model see Bridgewater: The Biggest Mistake In Investing
Behavioral Investing article source: The Brandes Institute.
________________________________________

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PART FOUR

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Value Vs. Glamour Stock Returns


What happens when value and glamour stocks miss earnings expectation targets? Although,
as expected, prices for glamour stocks have historically fallen, prices for value stocks have
gone up -- even when business fundamentals deteriorated, based on results found in this
study of global equities. These results suggest the superior returns delivered by value stocks
may not be a result of positive developments relative to expectations, but instead are more
likely due to a gradual and corrective reversal of earlier overreaction and mispricing. This
augments research by select scholars and provides fresh evidence explaining why value investing historically has been a successful long-term strategy. -- The Brandes Institute: The
Role Of Expectations In Value And Glamour Stock Returns
In this part of the timeless reading series Im looking at a study published by the Brandes Institute titled, The Role
Of Expectations In Value And Glamour Stock Returns.
The Brandes Institute is the research arm of Brandes Investment Partners and regularly produces comprehensive
research reports and videos on the topic of value investing, to help investors improve their investment process.
The Role Of Expectations In Value And Glamour Stock Returns looks at the markets relationship with glamour
stocks versus value stocks.. In particular, the study shows that, for the most part, investors tend to be over optimistic
when it comes to expectations for growth with glamour stocks while underestimating value stocks potential. For
example, the chart below shows the earnings growth of ten different (#1 to #10) companies across three years. The
blue line is the multiple of earnings the market is willing to pay for each company.

Investors pay less for value

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Company #10 is expected to earn $50,000 cumulatively over the next three years. Company #1 is only expected to
earn $19,000 over the same period, but the market is willing to pay 2.7x for the stock. Why? The market is willing to
pay a high premium for growth. Company #1s earnings are set to jump for $4,000 to $8,000 over three years, if this
growth continues, the company will earn an equivalent, if not greater level of earnings than company #10 at some
point in the future.
Investors are willing to pay more for glamour stocks. However, the Brandes Institute has found that the value/glamour
cycle has been surprisingly persistent and bordering on the predictable over the long-term:
We find a manifest chronology of overreaction, revision, sentiment shift, and multiple expansion in value stocks. In glamour stocks, a similar record of overoptimism,
revision, disappointment, and multiple contraction existed...the purchase of value
stocks tends to exploit, rather than succumb to, behavioral biases such as overoptimism, overreaction, and anchoring. These biases tend to push prices for securities
above or below their inherent worth. -- The Brandes Institute: The Role Of Expectations In Value And Glamour Stock Returns
The report notes that these biases, which push prices to extremes in the short-term, dissipate over the long-term, and
security prices revert away from extreme levels.
As prices make this reversion, we believe there are ample opportunities for profitminded investors who can remain rational and patient. -- The Brandes Institute:
The Role Of Expectations In Value And Glamour Stock Returns

Why has value investing worked?


Theres plenty of evidence that supports the conclusion that value investing outperforms over the long-term. Why
this has been the case seems to have something to behavioral errors. Its often the case that investors associate value
stocks with companies that continually disappoint. As a result, theres a perception that owning them is a direct path
to poor returns. On the flipside, there are stocks that have exceeded expectations in the past, appear to offer promising results, and whose stock prices have leapt with each positive development. Such stocks bring investors comfort
and confidence. Accordingly, many investors have high expectations for such stocks and, sentiment that borders on
adoration.
The study from the Brandes Institute is over 20 pages long, so I have to summarize the argument here.
Nevertheless, its clear from the study that investors of both value and growth disciplines are affected by emotional
biases that impact the returns on value and growth stocks. For value stocks, after the initial event that caused a selloff, after an average cool down period of 12 months, investors reverted to a less emotional and behaviorally biased
disposition. A more balanced assessment of fair value ensued, and sentiment began to shift.
Most notably in this study, company fundamentals neednt immediately improve for this progression to begin. The reappraisal was a slow progression with bumps along the way, amounting
to years of subsequent outperformance delivered by value stocks.

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With growth stocks, it was found that overoptimism set expectations for growth at unattainably high levels -- required
to sustain already elevated stocks prices. Eventually, it then becomes increasingly difficult for a company to meet
growth targets. At some point in the future, eventually, growth expectations will be missed (typically by a wide margin), and expectations will be revised downwards. Investors then become rattled, and prices fall leading to multiple
contraction.
The numbers in the table below really do sum up the argument nicely.

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PART FIVE

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Financial Academics On Value


Are markets efficient? Should you subscribe to the efficient market hypothesis? There is plenty of research on both
the EMH and traditional value strategies. In fact, the volume of data on the subject is somewhat overwhelming.
In a simple, short blog post published in 2011, Professor Tano Santos Co-Director of the Heilbrunn Center for Graham and Dodd Investing presented a strong argument against the EMH and Capital Asset Pricing Model as a way of
measuring risk and producing returns.
Professor Santos deconstruction of the CAPM has many similarities to Fama and Frenchs study, The Capital Asset Pricing Model: Theory and Evidence (2004), which concludes that the empirical evidence invalidates the use of
CAPM in applications, after finding that passive funds invested in low beta, small or value stocks tend to produce positive abnormal returns relative to CAPM predictions. Simply put, Fama and French found that those using the CAPM
tend to invest more heavily in higher risk investments than is optimal.
Professor Santos work takes a different approach to that of Fama and French. Specifically, Santos highlights the differences between that of the academics study of value, and that of traditional value investors. While the academics
concentrate on figures alone, value investors look into the very depths of the company before making a trading decision, to obtain the best results with the least risk.
Still, by using market data, over the past five decades those stocks with the lowest price to book values in the market
have outperformed the stocks with the highest price to book multiples by an average of 7.1% per annum. This 7.1%
has been labeled the value premium
When academics find a premium, any premium, the first question they ask themselves is:
Why does this particular strategy or portfolio command such a premium? Or to put it differently: What is the source of risk embedded in value stocks that requires compensation in the
form of large returns if these stocks are to be held by investors? And if risk cannot explain
it, what can?

CAPM & value


The CAPM is the most common model for assessing financial risk, and according to the CAPM, stocks that produce
a higher return should have a higher beta. Or to put it another way, to achieve higher returns, according to the CAPM
you need to take on more risk.
So, did the value stocks that outperformed by 7.1% per annum over five decades have a higher beta than the high price
to book value group? The answer is no, as shown below.

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This chart is from Professor Santos post on value. The gray line shows the returns of ten portfolios over a five decade
period. On the left, the portfolio of stocks with the lowest price to book values. On the right, the portfolio of stocks
with the highest price to book values. The blue line is where the returns should be if beta were an accurate measure of
risk and the CAPM held true in all cases. As the chart shows, its not always necessary to take on more risk to achieve
higher returns.
...the point that it delivers is nevertheless striking: the CAPM cannot explain any of the
variation in returns associated with variation in book-to-market. In particular notice that the
CAPM says that value stocks should have much lower returns than what they have in the
data! The inability of the CAPM to explain the value premium is what academics call the
value premium puzzle
Experienced value investors should know the answer to this puzzle; Mr. Market is to blame.
So why do academics keep arguing over what perhaps many a practitioner considers an
obvious issue: that Mr. Market is prone to temporary periods of insanity, euphoria, and depression? Because the market is the fundamental allocation mechanism and if in some loose
sense the market is not efficient...well perhaps society should consider the appropriate public
interventions to improve on what otherwise would be a suboptimal allocation of capital. You
can see now why academics worry so much about this issue: The question is not academic
at all! It affects the organization of our economic life in ways that are sometimes not fully
appreciated by even the best-informed investors.

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PART SIX

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Value Versus Growth, The International Evidence


In part five of this series, Financial Academics On Value, I mentioned Eugene Fama and Kenneth Frenchs study, The
Capital Asset Pricing Model: Theory and Evidence (2004). This study, conducted by Fama and French concluded that
the use of the CAPM in many applications is misguided. The figures showed that passive funds, which invested in low
beta, small or value stocks tend to produce positive abnormal returns relative to CAPM predictions.
This part of the timeless reading series is dedicated to another study by world-renowned researchers Eugene Fama
and Kenneth French.
Value Versus Growth: The International Evidence is one of the most comprehensive studies on the long-term
performance of value strategies versus growth. The data used for the study was taken from portfolios of growth and
value stocks in the US and 12 other major developed economies over the period 1974 to 1994.
Using the three decades of data, Fama and French sorted stocks into value and growth categories. Value stocks were
defined as those stocks with the lowest price to book value while growth stocks were defined as those with a high ratio
of book value to market value.

Data quality
The average company specific figures for US stocks used in the study were as follows. The average
book-to-market equity value for low book-to-market stocks used in the study was 0.4x. The average
book-to-market equity value for high book-to-market stocks used in the study was 1.6x. The average
company market cap. was $431 million and median size $42 million. Due to the size of the US and
Japanese markets, these two stock universes accounted for 75% of the studys results.
One thing to note about Fama and Frenchs study is the fact that they used the MSCI database to
calculate returns. MSCI is just a compilation of hard-copy issues of Morgan Stanleys Capital International Perspectives. It includes historical data for firms that disappear, but does not include historical
data for newly added firms, so there is no backfilling problem. As a result, the data is relatively free of
survivor bias, which makes the study more indicative of real-life trends than most.

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Value vs growth -- Photo credit: http://systematicrelativestrength.com/2010/11/22/value-or-growth-which-is-better/

Study results
Results of the study showed that the difference between average returns on global portfolios of high
and low book-to-market equity stocks was 7.60% per year. Value stocks outperformed growth stocks
in 12 of 13 major markets during the 1975-1995 period. Whats more, similar return premiums were
also reported when sorting the stocks in order of earnings/price, cash flow/price, and dividend/
price.
It was found in many cases that the markets high expectations for growth stocks held back their
long-term performance. Specifically, the market often pegged a high valuation on growth stocks from
the very beginning, leaving them no choice but to grow into their valuation. After growing into lofty
valuations, growth tends to slow, and the valuation adjusts accordingly.

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...people think because these are good companies, their stock returns will be
high. But in fact, their prices are pegged so high by the market that their returns
actually tend to be low...The intuition is that value stocks have low prices relative
to their book value, so the market feels theyre relatively distressed...The intuition is the opposite for growth stocks. -- Eugene Fama
Fama and French put together Value Versus Growth: The International Evidence as part of their
findings in the process of examining the validity of the Capital Asset Pricing Model, which has
been used for decades as a means of describing the relationship between expected return and risk in
stocks. Fama and French found that CAPM couldnt possibly explain all the variation in expected returns. Further, by using the CAPM and relying on just one measure of risk (beta) Fama and Frenchs
research showed that those investors using CAPM tend to take on more risk than is optimal (something I covered in part five of this series).
CAPMs downfalls
After presenting evidence to display CAPMs downfalls, Fama and French went on to examine multifactor models that allow many different sources of risk to impact expected returns. They found that
to explain average stock returns, the most efficient strategy is to use three measures of risk. These
measures include sensitivity to the market return; a measure to distinguish the risks in small stocks
versus big stocks; and a measure to identify the risks in value stocks versus growth stocks.
Value Versus Growth: The International Evidence uses two measures of risk to explain the average
returns -- a market risk factor and a value-growth risk factor. The market risk factor is the return on
an international market portfolio of stocks, and the value-growth factor is the difference between the
return on an international portfolio of high book-to-market stocks and the return on an international
portfolio of low book-to-market stocks.
And the results do support the conclusion that CAPM gives too simplistic a view of the world. Additionally, the results present hard evidence, which supports the argument that, over time, value always
outperforms growth.

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PART SEVEN

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Untangling Skill And Luck


Are your portfolio returns down to skill or luck? Have you outperformed due to stock picking skill or just good luck,
aided by the wider market rally? Conversely, has your portfolio underperformed due to a run of bad luck or poor
decisions? Its hard to tell.
Those that outperform are more likely to say that it was their skill that yielded results. While those investors that have
lagged the market are most likely to blame a run of bad luck.
Michael Mauboussin, the head of Global Financial Strategies at Credit Suisse Group AG, looked at the key distinctions
between skill and luck in his book The Success Equation: Untangling Skill and Luck in Business, Sports and Investing.
Mauboussin has also published a paper entitled, Untangling Skill And Luck: How to Think About Outcomes--Past,
Present, and Future while he was working at Legg Mason Capital Management, and its this paper thats earned a place
in ValueWalks timeless reading series.

Defining skill and luck


Its important to define skill and luck before we get too far into the discussion.
Skill is the ability to use ones knowledge effectively and readily in execution
or performance. You can think of skill as a process, or a series of actions to
achieve a specific goal. Luck is the events or circumstances that operate for or
against an individual. Luck, in this sense, is above and beyond skill. Consider
luck as a distribution that has an average of zero. By this definition, luck tends
to be transitory. -- Michael Mauboussin Untangling Skill and Luck
Outcomes from many activities are a combination of skill and luck. Warren Buffett himself has stated
that a small portion of his success can be attributed luck. However, investors often fail to distinguish
between skill and luck. For example, in the aggregate institutional money tends to flow to assets that
have done well and fails to consider sufficiently the role of luck. According to Mauboussin, one recent study showed that the misallocation of resources cost a select set of institutional portfolios $170
billion in lost performance from 1985 to 2006.
The studys authors conclude that those institutions could have saved hundreds of billions of dollars in assets if they had simply stayed the course instead of moving money based on a naive extrapolation of past results.
Once you understand the principles behind skill and luck, its pretty simple to distinguish between
the two. And the easiest way to describe the difference between the two is to ask the simple question:
Can you lose on purpose?
Activities that require skill to excel at can be lost intentionally. However, games such as roulette or the
lottery cannot lost on purpose. Therefore, their outcome is determined by luck.

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A certain degree of luck


Investing requires a lot of skill and a certain degree of luck. Over the long-term, investing success is determined by
skill but in the short-term, performance has a lot to do with luck.

There is a lot of skill in markets and investors themselves are all very similarly
skillful this is reflected in prices. As a consequence, that leaves more to luck
and is the reason why short-term outcomes can mostly be put down to luck.
-- Michael Mauboussinsource.
The key to improving investment performance then is to define, refine and improve skill. Appreciating the difference
between skill and luck is the first step on this journey. Then you have to focus on the process. You need to ask yourself
if your investing process is any good? Has it worked in the past?

I think of good processes as having three essential elements. Element one is


analytical: having an ability to find situations in which you believe something
the world doesnt believe and in which you have a good foundation for such a
belief.
The second is behavioral: we are all subject to behavioral mistakes and cognitive biases. Are you aware of those things and are you taking steps to manage or
mitigate them? The third, which is less true for individuals and truer for organi-

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zations, is what I call institutional. This element relates to the constraints in


your personal or professional life that dont allow you to do the best thing
possible in terms of your process -- Michael MauboussinForbes
If youve done that, and you get a bad outcome in the short term, you pick yourself up, dust yourself off and you go
back at it the next day because over time the process will lead to success. The key is providing good feedback, something youre able to do with an investment process.

The best way to ensure satisfactory long-term results is to constantly improve


skill, which often means enhancing a process. Gaining skill requires deliberate
practice, which has a very specific meaning: it includes actions designed to improve performance, has repeatable tasks, incorporates high-quality feedback, and
is not much fun. Deliberate practice works well in domains that are dominated by
skill
The key, then, is to focus feedback on improving skill. This is a very difficult task
in activities where luck plays a big role. For example, this means that in evaluating
an analyst or a portfolio manager, it is much less important to see how she has
done recently...than it is to assess the process by which she did her job. Embracing
and implementing this point of view is demanding. And make no mistake about it:
the reason to emphasize process is that a good process provides the best chance
for agreeable long-term outcomes.
Skill is key to long-term investing success, and skill is developed through a structured investment process, the returns
of which shouldnt be measured over the short-term as short-term results can be influenced by luck, not skill.

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PART EIGHT

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The High Dividend Yield Advantage


Part seven of this series is devoted to yet another a research booklet published by Tweedy, Browne Company LLC.
Part two of the series was devoted to Tweedy, Brownes booklet, What Has Worked In Investing.
Tweedy, Browne has become synonymous with value investing over the years. Founded in 1920, Benjamin Graham
was one of the firms primary brokerage clients in the 1930s, 1940s, and 1950s. Then during 1959 the partners of
Tweedy, Browne and Tom Knapp (who had joined from the Graham-Newman) pooled their capital in a partnership
investment vehicle. You can read more about Tom Knapp at ValueWalks exclusive Tom Knapp Resource Page.
Its quite simple. Stocks with relatively high, sustainable dividend yields outperform over the long-term.
Tweedy, Brownes booklet, The High Dividend Yield Return Advantage is an examination of empirical data associating investment in high dividend yield securities with attractive returns over long measurement periods. The booklet
begins:
In the pages that follow, we set forth a number of studies, largely from academia,
analyzing the importance of dividends, and the association of high dividend yields with
attractive investment returns over long measurement periods. You may be familiar with
our prior booklet, What Has Worked In Investing, where we provided an anthology of
studies which empirically identified a return advantage for value-oriented investment
characteristics. In the same spirit, we attempt to examine what some in our industry
have referred to as the yield effect; i.e., the correlation of high dividend yields to attractive rates of return over long measurement periods.

The High Dividend Yield Advantage: Dividends and long-term returns


The first study cited in Tweedy, Brownes booklet is from Elroy Dimson, Paul Marsh, and Mike Stauntons book,
Triumph of the Optimists: 101 Years of Global Investment Returns. This study is the most comprehensive study in
Tweedy, Brownes booklet as it looks at data spanning the period 1900 to 2000, examining the respective contributions
to returns provided by capital gains and dividends. Over 101 years, they found that by reinvesting dividends a marketoriented portfolio would return 85x more than a similar portfolio, which relied solely on capital gains.
These figures are both highly impressive and more reliable than any other study out there due to the extensive amount
of data used. The chart below sums up the argument quite well.

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The High Dividend Yield Advantage: High dividend yield outperforms


The next most informative study from Tweedy, Brownes booklet is another long-term study from the Dimson, Marsh
and Stantons book. This study looked at the cumulative returns from 1926 to 2000 of US stocks that ranked each year
in the highest or lowest-yielding 30% of companies compared to the CRSP value-weighted equity index. The results:
Higher dividend yield stocks outperformed their lower-yielding counterparts and the
index by 180 and 160 basis points annualized from year-end 1926 to year-end 2000. This
translated into 2.29 times the wealth generated by the lower-yielding stocks.
Once again the chart below sums up the argument nicely.

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The High Dividend Yield Advantage: Not so simple


The evidence seems to suggest that by buying the highest yielding stocks youre chances of outperforming the wider
market are significantly improved. However, the evidence suggests that its not dividend yield, but dividend cover that
is the key factor investors need to look out for when hunting for the best long-term dividend plays.
In an equity research paper entitled High Yield, Low Payout, Credit Suisse Group AG analysts Pankaj N. Patel,
Souheang Yao and Heath Barefoot found that highest yield stocks were not the overall leaders in terms of return. The
analysts ran a simulation of a dividend strategy from January 1980 to June 2006 using a universe of stocks within the
S&P 500 and created equal-weighted declie baskets based on dividend yields.
Over 26-year period studied; they found a direct correlation between low payout ratios and higher returns within the
higher dividend yield universe. To take a deeper look at this trend they created three dividend yield baskets ranked
by yield; i.e., high yield, low yield, and no yield. Then, within each of these baskets they categorized stocks based on
payout ratio; i.e., high, medium and low. Equal-weighted portfolios of these baskets were created based on dividend
yields and payout ratios as of each quarter-end for the period January 1990 to June 2006. The high yield, low payout
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portfolio bucket generated an annualized return for the period of 19.2% versus 11.2% for the S&P 500. On the other
hand, the high dividend yield, high payout ratio bucket produced an annualized return of only 11.0%, underperforming the S&P 500.

The High Dividend Yield Advantage: International evidence


All of the above studies have concentrated on the performance of high yield US equities, but theres also plenty of
evidence to show that high dividend yield stocks around the world consistently outperform.
Two studies within Tweedy, Brownes booklet look at the returns of high dividend yield stocks outside the US. The
first was taken from The Journal of Portfolio Management. Titled The Importance of Dividend Yields in Country
Selection and written by Michael Keppler, the study examined the relationship between dividend yield and investment
returns for companies throughout the world. Mr. Kepplers study assumed an equal-weighted investment each quarter
in each of the following eighteen Morgan Stanley Capital International equity indexes over the 20-year period from
December 31, 1969, through December 31, 1989: Australia, Austria, Belgium, Canada, Denmark, France, Germany,
Hong Kong, Italy, Japan, The Netherlands, Norway, Singapore/Malaysia, Spain, Sweden, Switzerland, the United
Kingdom, and the US. Results are shown in the chart below.

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The Importance of Dividend Yields in Country Selection The High Dividend Yield Advantage
The second international study comes from OShaughnessy Asset Management and is entitled Stocks, Bonds, and the
Efficacy of Global Dividends. Using data from Morgan Stanley Capital International (MSCI) going back to 1970,
OShaughnessy Asset Management found that the top decile of dividend paying companies in that database produced
returns that were 5.7% better, on an annualized basis, than the returns of the broader database.

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PART NINE

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Seth Klarman Margin Of Safety


A series on the best resources for value investors wouldnt be complete without an article devoted to one of the many
legendary value investing books on the market. And there are many to choose from, too many to list, but theres one
that stands out from the rest.
Seth Klarmans out of print book, Margin of Safety is essential reading for all serious value investors. A print copy of
the book is almost impossible to get hold of and second-hand copies have been known to appear on Amazon.com
for in excess of $1,000.
So, this part of the timeless reading series is dedicated to some of the most valuable nuggets of information contained
within Margin of Safety.

Seth Klarman on the greatest challenge


...The greatest challenge for value investors is maintaining the required discipline. Being a value investor usually means standing apart from the crowd, challenging conventional wisdom, and opposing the prevailing investment winds. It can be a very lonely
undertaking -- Seth Klarman, Margin of Safety
Over the short-term, there may be periods where the value approach seems outdated and ill-conceived. However, over
the long-term, the devoted advocates of the strategy are rewarded and the value approach works so successfully that
few, if any, advocates of the philosophy ever abandon it. The message here is stick to your principles, dont over trade
and believe in the value discipline. Value investors have to keep the discipline, no matter how bad things many seem.

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Seth Klarman notes that many investors are often pressured into investing prematurely; the cheapest security in an
overvalued market may still be overvalued. It is often the case that another opportunity to buy will come along soon,
offering a better return for your money.
Nevertheless, value alone is not sufficient; investors must choose only the best absolute values among those that are
currently available. Oddly, this is where Seth Klarman advocates increased trading or rebalancing.
... Value investors continually compare potential new investments with their current
holdings in order to ensure that they own only the most undervalued opportunities
available. Investors should never be afraid to reexamine current holdings as new opportunities appear, even if that means realizing losses on the sale of current holdings

Seth Klarman on reducing portfolio risk


...Portfolio management requires paying attention to the portfolio as a whole, taking
into account diversification, possible hedging strategies, and the management of portfolio cash flow. In effect, while individual investment decisions should take risk into
account, portfolio management is a further means of risk reduction for investors
How many stocks should you hold to be suitably diversified? In Klarmans view, ten to 15 is suitable. The reason for
such a small portfolio size:
...My view is that an investor is better off knowing a lot about a few investments than
knowing only a little about each of a great many holdings. Ones very best ideas are
likely to generate higher returns for a given level of risk than ones hundredth or thousandth best idea

Seth Klarman on leaving room to average down


As Seth Klarman explains:
...The single most crucial factor in trading is developing the appropriate reaction to
price fluctuations...One half of trading involves learning how to buy. In my view, investors should usually refrain from purchasing a full position (the maximum dollar commitment they intend to make) in a given security all at once...Buying a partial position
leaves reserves that permit investors to average down, lowering their average cost per
share, if prices decline...If the security you are considering is truly a good investment,
not a speculation, you would certainly want to own more at lower prices. If, prior to
purchase, you realize that you are unwilling to average down, then you probably should
not make the purchase in the first place

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Seth Klarman on the art of business valuation


Of course, achieving an appropriate margin of safety is entirely dependent upon the ability of the
investor to be able to place a suitable value on the underlying business. In a warning to potential investors, Seth Klarman states that:
...Reported book value, earnings, and cash flow are, after all, only the best guesses of
accountants...Projected results are less precise still...You cannot appraise the value of
your home to the nearest thousand dollars. Why would it be any easier to place a value
on vast and complex businesses?...if expert analysts with extensive information cannot gauge the value of high-profile, well-regarded businesses with more certainty than
this, investors should not fool themselves into believing they are capable of greater
precision when buying marketable securities based only on limited, publicly available
information
This is clearly a warning to all those who invest based on book values and reported financial figures alone. Its also the
basis of the margin of safety principle. Seth Klarman is wary of figures such as net present value and the internal rate
of return, they are only as accurate as the values and assumptions used to calculate them.

Seth Klarman on selling: The hardest decision of all


Anyone over the age of 18 can buy a stock. The most difficult part is selling. Some investors have targets on when to
sell if the P/B value hits one, or P/E exceeds 15. These are rules Seth Klarman considers to be useless. Just like decisions to buy, decisions on when to sell must be based on the business underlying value, which will of course change
regularly.
It may be silly to wait for full value realization. For example, missing out on half a point of profit when other opportunities are available is not the end of the world. Its be better to take profits and reinvest with a new, wider margin of
safety. Stop losses should not be used:
...Some investors place stop-loss orders to sell securities at specific prices, usually
marginally below their cost...Although this strategy may seem an effective way to limit
downside risk, it is, in fact, crazy...a user of this technique acts as if the market knows
the merits of a particular investment better than he or she does (Using stop losses
puts Mr Market in control.)
Making the decision to sell is tough, it requires constant work to value the underlying business. Still, deciding on when
to sell is without a doubt more important than deciding on when to buy.
...If you havent bought based upon underlying value, how do you decide when to sell?
If you are speculating in securities trading above underlying value, when do you take a
profit or cut your losses? Do you have any guide other than how they are acting, which
is really no guide at all?

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Seth Klarman on short-termism


On top of the need and commissions eating away at returns, Seth Klarman writes that Wall Street is increasingly focused on short-term returns, which are driven by an up-front fee orientation. Brokers, traders, and investment bankers
all find it hard to look beyond the next transaction, when the current one is so lucrative regardless of merit.
The great majority of institutional investors are plagued with a short-term, relativeperformance orientation and lack the long-term perspective that retirement and endowment funds deserve
With Wall Street focused on short-term benchmarks and performance, Seth Klarman writes that the Street has now
lost the ability to management money over the long-term. Pension funds and institutions are now the greatest stockholders in terms of volume, outnumbering private investors but institutions are no more qualified that private investors to look after your money. As Seth Klarman writes:
If the behavior of institutional investors werent so horrifying, it might actually be
humorous...The prevalent mentality is consensus, groupthink. Acting with the crowd
ensures an acceptable mediocrity; acting independently runs the risk of unacceptable
underperformance
Many readers will know that Wall Street is biased and has a short-term focus, therefore, cannot be trusted. So how can
value investors benefit? As usual, Seth Klarman has the last say on the matter:
...Investors must try to understand the institutional investment mentality for two reasons. First, institutions dominate financial market trading; investors who are ignorant
of institutional behavior are likely to be periodically trampled. Second, ample investment opportunities may exist in the securities that are excluded from consideration
by most institutional investors. Picking through the crumbs left by the investment elephants can be rewarding...
Unfortunately, its not easy for investors to distinguish temporary volatility, from price movements related to business
fundamentals. In this case, the reality may only become apparent after the fact. Seth Klarman is looking for long-term
outperformance, not short-term trading patterns:
...If you are buying sound value at a discount, do short-term price fluctuations matter?
In the long run they do not matter much; value will ultimately be reflected in the price
of a security
Even when Margin of Safety was written, Seth Klarman noted that many investors were actually buying and selling securities with little or no fundamental knowledge of the underlying businesses. So, when Mr. Market throws his toys out
the pram, investors panic and opportunities to buy at discounted price present themselves at a rapid pace. A high level
of liquidity, coupled with a knowledge of day-to-day market movements can result in plenty of value opportunities.

Seth Klarman on investment fads


Its not only single securities that can become overvalued, whole industries can see their valuations rocket as they become an investment fad and note, when an industry is in fad mode, very few Wall Streeters will call the fad out. The
e-cig, marijuana, and solar industry are three current example.

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It is only fair to note that it is not easy to distinguish an investment fad from a real business trend. Indeed, many
investment fads originate in real business trends, which deserve to be reflected in stock prices. The fad become dangerous however, when share prices reach levels that are not supported by the conservatively appraised values of the
underlying business
________________________________________

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PART TEN

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Timeless Wisdom for Creating Long-Term Wealth


The final part of this series is devoted to two documents, both of which have been put together by Davis Advisors,
the $40 billion mutual fund powerhouse founded by Shelby Davis -- the son of Shelby Cullom Davis.
These two documents are short PDFs, which are designed to be collections of wisdom. They pull together the ideas
and thoughts from some of historys most successful value investors to help the reader improve their investing process.

Timeless Wisdom for Creating Long-Term Wealth


The Wisdom of Great Investors

What follows is a condensed version of the two collections of timeless wisdom.


Use a Systematic Investment Approach
The first piece of timeless wisdom comes from the Godfather of value investing, Benjamin Graham.
Systematic investing will pay off ultimately, regardless of when it is begun, provided
that it is adhered to conscientiously and courageously under all market conditions.
Benjamin Graham favored systematic investing because it involved investing money in equal amounts at regular intervals, regardless of the market environment. Similar in many respects to dollar cost averaging, a systematic investment
strategy has two key benefits. Firstly, it encourages the disciplined, unemotional mindset required to be a successful
investor. And secondly, it capitalizes on market uncertainty and volatility. When the same amount is invested every
month, should the market drop, more shares are automatically purchased at more attractive prices.
This strategy can help the average investor outperform when uncertainty prevails in the market. For example, during
the brutal bear market from 1929 to 1954 the Dow Jones Industrial Average returned only 5.4% per year. However, a
systematic investor who committed money each year saw returns of 11.7% per year.

Avoid Self-Destructive Investor Behavior


A lot of people with high IQs are terrible investors because theyve got terrible temperaments. You need to keep raw irrational emotion under control. -- Charlie Munger
Most investors are controlled by their emotions, and while systematic investing helps investors to ignore their emotions, self-destructive behavior still eats away at returns. Davis Advisors present two charts to illustrate the destructive
effect poor decision have on wealth creation.

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As shown in the chart above, between 1995 and 2014 the average stock fund returned 9.1% annually, but the average
investor in stock funds earned only 5.2%. Why was this the case? The chart below offers an explanation.

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Investors are guided by their emotions. By trying to time the market, chasing hot investment and avoiding out-offavor areas they are holding back their performance. When building long-term wealth, maintaining an unemotional,
rational and disciplined mindset is critical. Making emotional decisions based on short-term market movements can
have disastrous consequences.

Dont Attempt to Time the Market


The idea that a bell rings to signal when investors should get into or out of the stock
market is simply not credible. After nearly fifty years in this business, I do not know of
anybody who has done it successfully and consistently. I dont even know anybody who
knows anybody who has done it successfully and consistently. -- Jack Bogle
Market corrections often cause investors to abandon their investment plans moving out of stocks when the outlook
appears bleak with the intention of moving back in when things seem better. However, successfully timing the market
is practically impossible and if you doubt this view consider the chart below.

The chart compares the returns of 20-year returns of an investor who stayed the course over the entire period to those
who missed just the best 10, 30, 60, or 90 trading days. And as you can see, the investors that missed just the best 30
days during this 20 year period experienced an investment that remained flat. Being out of the market for a full 90
days would cost a 8.6% per annum.

Understand That Short-Term Underperformance is Inevitable


History has shown that even the most successful investors have encountered stretches
of poor performance. Such stretches are inevitable and will measure whether an investor has the conviction, courage and discipline necessary to beat the market over the
long term. -- Shelby Cullom Davis
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It is impossible to predict accurately the short-term direction of the market, and as a result, investors need to remember that when evaluating managers (or their own investment strategy), short-term performance is not a strong
indicator of long-term success.
Investors who recognize and prepare for the fact that short-term underperformance is inevitable may be less likely to
make unnecessary and often destructive changes to their investment plans.

Recognize That Historically, Periods of Low Returns for Stocks Have Been Followed by Periods of
Higher Returns
Historically, disappointing periods for the market have been followed by periods of
recovery. Why? Because disappointing periods provide long-term investors the opportunity to purchase good businesses at lower pricesand lower entry prices have helped
increase future returns. -- Chris Davis
Based on data spanning the past nine decades, history has shown that investors should feel optimistic about the longterm potential for stocks after a disappointing period.

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Long-term investors should always consider adding to their equity holdings following periods of poor returns. Trying
to time the market by getting out of the market after a period of poor performance may sabotage your ability to build
wealth.

A Market Correction is an Opportunity for the Patient, Long-Term Investor


A market downturn doesnt bother us. For us and our long-term investors, it is an
opportunity to increase our ownership of great companies with great management at
good prices. Only for short-term investors and market timers is a correction not an
opportunity. -- Warren Buffett
A piece on the wisdom of historys greatest investors wouldnt be complete without a section on Warren Buffett.
Buffett is perhaps best known for his long-term outlook and contrarian nature, both of which are traits that have
helped him build his wealth over the years. The benefits of long-term investing are covered above. This section is
devoted to the benefits of contrarian and opportunistic investing.
The chart below illustrates how four different investor reactions to a market correction can impact returns. Four
hypothetical investors each invested $10,000 in the market from January 1, 1972, to December 31, 2013, but all four
investors acted differently during the 1973 to 1974 bear market. The Nervous Investor sold out and went to cash. The
Market Timer sold out but moved back into stocks on January 1, 1983, at the beginning of a historic bull market. The
Buy and Hold Investor held steady throughout the period. And lastly, the Opportunistic Investor realized that the bear
market had created opportunities and contributed an additional $10,000 to his original investment on January 1, 1975.

(C)
ValueWalk
2015 - All rights Reserved
Charlie
Munger

50

TIMELESS READING

Stocks Historically Have Been the Best Way to Build Wealth, Despite Inevitable Periods of Uncertainty
There is always something to worry about and a hundred reasons not to invest. Those
who abandon stocks because of fear or uncertainty may pay a tremendous price. History has shown that a diversified portfolio of equities held for the long term has been
the best way to build real wealth. -- Shelby M.C. Davis
Below is a chart showing the cumulative inflation-adjusted returns from 1925 to 2013 for stocks, bonds, Treasury bills,
and the U.S. dollar. Over the period studied, there have been multiple wars, recessions, bear markets, financial crises
and market panics. Whats more, the Great Depression started in 1929, and Financial Crisis took place in 2009.
Nevertheless, despite all of these obstacles large-cap stocks have outperformed all other asset classes over the period.

(C)
ValueWalk
2015 - All rights Reserved
Charlie
Munger

51