There’s a style of investing called value investing, where investors buy wonderful businesses at attractive prices and then sell them when they’re priced in excess of their value. It’s an investment strategy pioneered by Benjamin Graham, author of The Intelligent Investor, and popularized by Warren Buffet, whom Graham mentored. At its core, it’s about understanding the difference between value and price and having a mindset of owning a business versus merely buying a stock.
Accountants are financial experts. At the most detailed level, we understand what makes a business run. And at the highest levels, we understand how a business fits into the broader industry and economy. Because of our strong analytical skills and number crunching abilities, accountants have what it takes to be skilled value investors.
Durable Competitive Advantage
What’s a “wonderful business”? It’s a business with high potential for growth that has a durable competitive advantage (or several), often called a moat. A moat protects the company’s customers and profits from competitors. Examples of moats are unique products or services or strong brands, or proprietary products and procedures or trade secrets. A business can also have a “switching” moat, products or services that are “sticky” - so much a part of your life that switching is not worth the trouble. Other businesses have price moats, prices so low that few others can compete.
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1. Return on Invested Capital – the rate of return on the cash a company puts back into the business every year.
2. Sales Growth Rate – the rate at which revenues are growing (or shrinking) over a given period.
3. Earnings per Share (EPS) Growth Rate – indicates how much the business is profiting per share of ownership.
4. Equity Growth Rate – indicates if the profits are accumulating for the owners or are being spent each year to replace equipment and other capital items.
5. Operating Cash Flow Growth Rate – focuses on the cash being generated by business operations. As accountants, we have a detailed understanding of how cash flow differs from earnings calculated on the accrual basis.
Price vs. Value
“Price is what you pay. Value is what you get.” – Warren Buffet
Price is the “sticker price”, the price at which the market is offering shares for purchase or sale. On the one hand, price can be quite volatile, swinging from low to high and back again, often without rational explanation. Graham referred to this as “Mr. Market”, a crazy person subject to wild mood swings. Each day he offers to buy your share of the business or sell you his share of the business at a particular price. When he’s in a good mood, Mr. Market names a price much higher than the true worth of the business. Those are the days you want to sell. On other days, when he’s in a bad mood, he names a very low price for the business. Those are the days you want to buy.
On the other hand, value, often called intrinsic value, is what a company is actually worth. It is calculated using fundamental financial analysis, something accountants are trained to do. We also understand that the underlying value of a business moves around a lot less than the price.
A good business isn’t necessarily a good investment. As a value investor, you’re looking for a wonderful business run by honest, talented, stakeholder-oriented management that is priced below its intrinsic value.
Margin of Safety
“The secret to investing is to figure out the value of something – and then pay a lot less.” – Joel Greenblatt, author of The Little Book that Still Beats the Market
Once you identify a wonderful business, calculate its actual value. Once again, accountants have training in valuation methods such as discounted cash flow, and have the skills to make assumptions and calculate intrinsic value. Then try to buy it on sale. A company may go on sale because of a company-specific event. Sometimes an economic event, such as the COVID-19 pandemic, will put most companies on sale.
By buying a company at a discount to its intrinsic value, you’re building in a buffer, also known as a “margin of safety”. This term was coined by Graham and refers to the ability to buy the company on sale, relative to its known value. (Margin of Safety is also the name of a book by Seth Klarman.) A buffer will protect your investment in the event that some of the assumptions made in calculating intrinsic value prove to be incorrect or if some unforeseen problem temporarily arises at the company.
Value investing is simple, but it’s not easy. Like many things, the challenge lies in the execution. However, as accountants, we already have many of the skills needed to become successful investors.
A Chartered Professional Accountant by training, Robin Taub began her career at KPMG, transitioned into real estate, and then landed in the complex world of derivatives marketing at Citibank Canada. Today, she’s a professional speaker and the author of The Wisest Investment, Teaching Your Kids to Be Responsible, Independent and Money-Smart for Life. Robin lives in Toronto, where she and her husband have raised two (mostly) money-smart young adults. For fun, she loves to snowboard, cycle and (pre-COVID) go to concerts. She even got backstage once and met Bruce Springsteen. Ask her how – she loves talking about it!