The Value of Value

I think a key difference between value investing and momentum investing is the concept of value. Now perhaps the momentum camp has something equivalent. But if you have done your homework, you have some perception of what a stock or security is worth. What is the actual value!

That is such a critical metric. Because over time, a stock's price should approach its actual value. And by placing a value on a stock, it can give you the confidence to hold it, or perhaps even buy more if it becomes cheaper or has a lumpy quarter.

That is why when you read books by Graham or Klarman, they focus so much on "risk" and "margin of safety".  If you buy something for 50 cents that is actually worth a dollar, it is not "risky", even if the stock price itself has inherent volatility.

Greenblatt has a terrific example in his book that he says he shares with his college classes. He picks several stocks and asks the class to look at the 52 week range.  Even for a large company, it is not unusual to see swings of 25 to 40% in a calendar year (from the top to the bottom). Does the intrinsic value of these companies actually swing that much during a "normal" 52 week stretch?  I think the answer is clearly no! It is the reverse, the market (using JG terminology) just goes "nuts" from time to time.  It is our job (as investors) to recognize that the market is nuts and to buy at the lower end of these ranges for the next 52 weeks. Again, that is where the concept of value is important.  You need to separate the stocks that have dropped for a legitimate reason (they have actually become less valuable) from those where the market has just gone nuts.