The Business of Value Investing.pdf

50 The Business of Value Investing

at which it was bought. However, value investors have one aim that

comes before realizing a capital gain. First and foremost, value

investing focuses on avoiding losses. Although loss aversion may

indeed be the goal of every market participant, it seems absent

in the decisions of many market bets. By investing at undervalued

prices, value investors avoid losses. Often undervalued securities

are found in areas unloved by the overall market, thus requiring

value investors to zig when most zag. Before making any invest-

ment, value investors consider and analyze not how much money

can be made but how much money can be lost. Mohnish Pabrai

sums it up succinctly when he remarks: “ Heads I win big, tails I

don ’ t lose much. ” 2

Buffett has immortalized value investors ’ aversion to capital

losses with his two top rules of investing:

Rule One: Don ’ t lose money.

Rule Two: Refer to Rule One.

The focus on capital preservation is of paramount importance

to the value investor. Value investors are not interested in situations

where the odds of a capital loss or gain are 50/50 or even 40/60.

The goal is to fi nd opportunities where the probability of loss is

minimal and there is a probability of a very high upside. Attention

to capital preservation requires that you pay attention to the value

of the business and ignore stock price fl uctuations, unless they pro-

vide an opportunity to buy at cheap prices or sell at fully valued

prices.

Focusing on the underlying business and not the stock price

allows you to understand the fi ne line between preservation of

capital and capital at risk of permanent loss. If you buy shares in

a business for $ 50 that you determine to have an intrinsic value of

$ 100, you shouldn ’ t panic if you see the stock price decline to $ 30.

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