Book Review > The Business of Value Investing: Six Essential Elements to Buying Companies like Warren Buffet

Sham Gad is the Managing Partner of the Gad Partners’ Funds.  Prior to this position, he ran the Gad Investment Group from 2002-05, a concentrated value fund that delivered annualized returns of 22 per cent.  He holds a MBA in finance from the University of Georgia, USA (2007) and has written hundreds of investment articles.

The aim of this book is to define and examine the essential framework that encompasses the foundation of value investing. The book centres on the concept that successful value investors have an ingrained mental framework through which all investment decisions are contemplated. This framework stems from Benjamin Graham, who told us in The  Intelligent Investor that ‘investment is most intelligent when it is most businesslike.’ Value investors are seeking discrepancies between business value and the stock price of those businesses in the market. ‘That’s all they do.’

The central concepts of value investing come down to six fundamental elements. Use of the word ‘element’ is deliberate. While these elements can be identified individually, it is critical to understand that all six come together to form a complete mental framework. Of even greater value, they can serve to spot any faults or mistakes that were made in investing.

The six elements in order, with a brief outline of their contents, are:

1. Before investing develop a sound mental philosophy of what  you are doing and understand that philosophy. Understand that you are investing in businesses, not stock prices. Avoid using borrowed money to make investments. ‘Leverage is the only way a smart investor can go broke’.
2. Have a good search strategy: always, always do your homework. This may not be for everyone, but Buffett’s method of researching stocks when he was younger was to examine Moody’s Investment Manual  spending ‘years going through the entire book, page by page, until he had gone through all 10 000 pages.’  The more time you spend, the more ideas you can generate.
3. Know how to value a business and assess the quality of management: business valuation is a blend of art and science. Judge management on the increase in book value of the company, over which it has complete control, not on stock performance which is controlled by the market.
4. In investing, and in life, having the discipline to say no can mean the difference between success and failure.  Maintaining a disciplined approach and not being emotional are difficult in investing, but the qualifications needed to do so are simple.  Being disciplined usually means avoiding what is popular on Wall Street.
5. Practice the art of patience: investment in stocks should be made with a long-term orientation. In the short-run, market prices are affected by the ‘votes of the market participants’. In the long run, stock prices will catch up with the fundamentals of the business.
6. Have the courage to make a significant investment at the point of maximum pessimism. This is the most difficult task in investing ‘appropriately’ and is the greatest determinant of investor success. Before this can happen investors need to be wired with the characteristics of the value approach; patience, discipline and risk aversion.

A later chapter crystallizes the thesis of the book by examining three investment case studies.  They were, at one time or another, all actual investments made by the author.  Chapter 11 concludes with reasons why many investors stumble often and advice about how to overcome these stumbling blocks.

At the end of each chapter there is a concise summary of the main points called ‘Key Takeaways’. This is a useful aid for the reader.

The book is based on the author’s experience with the US stock market. He recommends investors may benefit from joining the Value Investors’ Club which is a source of ‘phenomenal investment ideas’. This may not be an option for Australian readers. No doubt, the principles articulated would still be relevant to Australian conditions.

This book will appeal to both the new and more advanced student of value investing. For the former the book aims to provide a clear and concise illustration of its fundamental tenets, ‘which are ingrained in the mind and psyche of every successful value investor’. For the latter, including the active professional, it endeavours to add to the never-ending process of constant learning and application.     

Overall, I found the book to be well structured and easy to read. Included at the beginning of each chapter are timely quotes on investment philosophy from Buffett, Benjamin and others, including Australian financial writer Paul Clitheroe. (‘I don’t think investment is that hard.  It’s doing the simple things on a regular basis’.)

John Russell is a member of the AIA.