The Business of Value Investing.pdf

Invest Significantly at the Maximum Point of Pessimism 177

The fi rst three steps of the value investing framework rely

principally on analysis and research. While business valuation

does incorporate an element of art, most of the valuation process

is based on facts and statistical data. The remainder of the value

investing framework — discipline to say no, patience, and investing

at maximum points of pessimism — becomes much more diffi cult to

apply because it relies not on intelligence or IQ level but more on

temperament and emotion.

The discipline to say no goes beyond application to individual

securities. When presented with a security that is trading for sub-

stantially less than intrinsic value, the decision then rests on deter-

mining if the business meets the standards of quality and soundness

that will allow for (a) intrinsic value to increase over time and

(b) existence of future catalysts that will cause the stock price to

reach intrinsic value. Vastly more important is staying away from

the market euphoria that often leads to infl ated prices. One of the

core tenets of value investing is that whatever area of the market

the masses fi nd attractive is the area with little or no value at all.

For example, the 38-percent market decline in the Standard &

Poor’s 500 Index in 2008, the worst performance since 1931, led

to a massive exodus to the safety of U.S. Treasury securities. The

desire for the safety of cash was so high that the 3 - month Treasury

note was, at one point, actually yielding 0 percent. The 30 - year

Treasury was yielding only 2.53 percent, the lowest level in dec-

ades. 2 Frightened investors were willing to accept a negative real

rate of return in exchange for the safety of principal. Yet with the

United States government fully dedicated to fl ooding the markets

with newly printed dollars in order to resuscitate the economy, it

seems very likely that U.S. Treasuries are not the place to be at the

present moment. Having the discipline to say no and go against

the popular sentiment of the day requires investors to separate

themselves from the masses. It is not easy to make such a decision,

especially in the short run when it seems that the lone man out

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