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Value Investing's 10 Commandments

Contributed by mm | May 19, 2004 1:45 PM PST

Zeke Ashton contributed an excellent trilogy of important value investing tenets (part 1, part 2, part 3).

My excerpts:

I. Be an Investor, not a Speculator

Graham wrote that "there is intelligent speculation as there is intelligent investing." It is important, however, to know the difference. Speculating when you think you're investing is a good way to lose your money.

II. Don't Lose Money

Successful value investors learn to avoid investments that could result in substantial permanent capital loss by ensuring that they are getting at least a dollar's worth of value for every dollar invested.

III. Learn to Value Businesses

Every purchase of a stock should be driven by the conviction that the stock is selling for less than it is worth to a rational purchaser of the entire business, a conviction produced by confidence in one's ability to value the business in question.

IV. Know Your Circle of Competence

You can't make money in stocks unless you understand the business ... Every investing idea you consider offers a chance to widen or deepen your circle of competence, whether you act upon the idea or not.

V. Demand a Margin of Safety

In The Intelligent Investor, Benjamin Graham ventured the motto "margin of safety" in an attempt to "distill the secret of sound investing into three words." In 1990, Buffett wrote, "Forty-two years after reading that, I still think those are the right three words."

VI. Wait for the Perfect Pitch

The pressure to act, whether it is internal or external, must be resisted until a compelling investment idea presents itself.

VII. Make the Market Your Servant, Not Your Master

Short term supply and demand imbalances can create tremendous opportunity for the value-based investor. ... Rational investors do not look to the market for guidance, only opportunities.

VIII. Invest for Absolute, not Relative, Returns

Good absolute performance is obtained by purchasing undervalued securities while selling holdings that become more fully valued. For investors, absolute returns are the only ones that really matter; you cannot, after all, spend relative performance.

IX. Watch the Business, not the Stock

Don't confuse real success of an investment with its mirror of success in the stock market. The fact that a stock price rises does not ensure that the underlying business is doing well or that the price increase is justified by a corresponding increase in business value. Likewise, a price fall in and of itself does not necessarily reflect adverse business developments or value deterioration.

X. Know When to Sell

Buying businesses cheaply requires a willingness to go against the herd; selling businesses dearly requires parting with your investments when they are popular. You must learn to trust your own judgment rather than that of the market.

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