How I Became 100% Convinced that Value Investing Was The Superior Investing Methodology

The Value Investing Way: From Graham & Buffett, to Howard Marks, George Soros, Seth Klarman & Monish Pabrai

Chapters In This Article:

1. George Soros — Asymmetric Risk:Reward

2. Benjamin Graham — Promises Safety of Principal

3. Warren Buffett — Never Lose Money

4. Howard Marks — No Bad Asset, Only Bad Prices

5. Seth Klarman — Margin of Safety

Highlights

• This article is a primer of the respective investment philosophies of each of the value investing legends mentioned above.

• What really struck me was realizing that they were all talking about the same thing. It cemented to me that there was indeed true substance to value investing as an investment methodology.

• By pulling all of their respective investing quotes together, we can find the overlapping points between the independent lessons provided by all of these value investing legends in order to truly understand the principle of value investing — and subsequently begin generating superior LT outperformance in stock markets.

Do you see what I mean now? They’re all talking about the same thing.

This is what Value Investing really means.

Whenever the “Value Investing Way” is mentioned, Benjamin Graham’s seminal investing manuals Security Analysis and The Intelligent Investor immediately come to mind. However, what this article’s title is referencing is somewhat different. This article is a primer of the respective investment philosophies of each of the value investing legends mentioned — told through the lens of my personal investor journey, and the investing lessons which I learned from them in chronological order.

It is also the story of how I gradually came to find full faith in value investing as the superior investing methodology. I believe it is a story that will resonate with many readers.

For context, I’ve previously managed a $100M portfolio in an institutional capacity before, and as such am intimately familiar with many of the traditional institutional investing methodologies — e.g. factor investing, Sharpe optimization, and managing tracking error (i.e. portfolio volatility). I’m also an avid consumer of the interviews at Real Vision Finance and many other amazing Substacks with a similar institutional finance focus; and have developed a great degree of respect for more exotic approaches, such as options strategies (e.g. Diego Parilla, Mike Green) and macro strategies (e.g. Kyle Bass, Raoul Pal, DeMartino Booth, Lyn Alden). I also happen to have a pretty decent grasp of global macro, geopolitics, and history, both financial and otherwise.

So when I say that I’d finally settled on value investing as my preferred approach, it is not with the wide-eyed naivety of a Buffett apologist who hasn’t given other more traditional investing styles a chance. Rather, I say this with the firm conviction of someone who has been in a professional institutional capacity before — and finally concluding that value investing was the superior investing approach in terms of generating reliable LT outperformance.

Warren Buffett has previously said something to the effect of value investing — i.e. buying a dollar for 50 cents — being something that most people either get immediately or they don’t. If you’re new to value investing, this article will help you figure out if value investing is for you. By the end of this report, I hope to convince you that value investing is real — the way it has been to not just me, but millions of others around the world.

To facilitate familiarity, I shall be describing my investor journey with reference to the respective value investing legends in chronological order of my personal investor journey. Each of them and the respective lessons which they taught me represents one chapter of this article:

• Benjamin Graham — “An investment operation is one which, upon thorough analysis, promises Safety Of Principal and an Adequate Return.”

• Warren Buffett — “Rule No. 1: Never Lose Money.”

• Howard Marks — "We think no asset is so bad that there's not a price at which it's attractive for purchase, and no asset is so good that it can't be overpriced."

• George Soros — “It’s not whether you’re right or wrong that’s important. It’s about how much money you make when you’re right, and how much you lose when you’re wrong”.

• Seth Klarman — “There is nothing esoteric about value investing. It is simply the process of determining the value underlying a security and then buying it at a considerable discount from that value.”

• Monish Pabrai — “Heads I win, tails I don’t lose much.”

As we shall see later, the true magic from following the lessons of these Greats wasn’t simply learning independent lessons from each of them. Rather, it was the astounding realization that all of them were actually talking about the same thing — simply framed differently, given their different respective backgrounds (and lifetimes). It was this realization that hit me like a truck and convinced me that there was real substance to value investing, eventually leading me to throw my full weight behind it and jumping in with two feet.

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George Soros — Asymmetric Risk:Reward

George Soros may be an unusual place to begin my value investing journey, as he tends to be more recognized as a macro trader owing to his notoriety for breaking the Bank of England. However, he is indubitably a master of asymmetric risk:reward with thatm 1:40 risk:reward trade — which as we’ll see later, is one of the cornerstones of the value investing philosophy.

Stanley Druckenmiller credits Soros’s aforementioned quote as the greatest lesson that he ever learned while working under George Soros. However, like with many other value investing quotes, I initially didn’t truly appreciate what it meant and it mostly only served as a platitude to me.

It was only after watching Cathie Wood’s dramatic rise to fame during the pandemic and her subsequent fall from grace after the tech bubble burst that I became strikingly aware of how hyper-subject stock market consensus was to survivorship bias. At the height of the bubble she could do no wrong, and TSLA bears like Chanos and Einhorn were crucified; yet when the tech bubble burst and TSLA went down in flames, Wood’s successful history was basically forgotten and rewritten as a charlatan, while Chanos stole the spotlight from her. Now that TSLA is back up slightly, her reputation has since recovered and Wood is now relevant again.

This kind of “history is written by the victors” phenomenon in stock markets taught me one important lesson — what appears to work in stock markets when looking backwards (at historical share prices) cannot be replicated for the purpose of setting forward-looking investment strategy. This is mainly because when looking backwards, we have the benefit of 20/20 hindsight; whereas when planning forward, we will never have the benefit of hindsight — but are instead subject to heightened levels of uncertainty. This means that in markets where survivorship bias exists, backward-looking perspective represents an incomplete data set of the true risk:reward at the point of investment, and therefore inadequately informs forward-looking investment strategy.

From an actionable standpoint, this means that a forward-planning investor always has to be mindful about the role of Uncertainty in investment strategy — rather than assuming that he has zero blind spots and attempt to accurately forecast future target prices with pinpoint accuracy, the way a backward-looking investor might do. This makes investing in stock markets a game of probabilities rather than predictions, which is unfortunately what the status quo teaches us.

Ultimately, this led me to conclude that seeking asymmetric risk:reward was the optimal way to approach investment strategy, in contrast to accurate forecasting. I discuss this phenomenon in greater detail in the article below:

I still recall the related Eureka moment that I had like it was yesterday. At the time, I was mulling over my newfound conviction about risk:reward asymmetry as the optimal investing approach, when I recalled Soros’s aforementioned quote:

That’s when it struck me — was Soros not simply referring to risk:reward asymmetry all along? The actionable implication of his quote was that one shouldn’t be trying to forecast accurately (“it’s not whether you’re right or wrong that’s important”); but rather prepare for all possible outcomes and control for all possible exposures (“it’s about how much money you make when you’re right, and how much you lose when you’re wrong”).

The only responsible investment approach where heightened uncertainty is involved is a probabilistic bottom-up strategy which seeks to optimize for all possibilities — and ensures favorable outcomes in all possible timelines.

It is perhaps no coincidence that this lesson is also encapsulated by Monish Pabrai’s quote below from his book The Dhando Investor. Monish is quite outspoken that his investment strategy is simply to copy Buffett word-for-word in order to replicate his success:

“Heads I win, tails I don’t lose much.” — Monish Pabrai

What really struck me was that what both Soros and Pabrai are advocating for represents a radical departure from the traditional forecasting approach as practiced by >90% of stock market participants, wherein the entire exercise boils down to trying to identify future outcomes as correctly as possible. Dawning upon the authenticity and hyper-effectiveness of this approach towards generating investment outperformance was when I first began to genuinely lean into value investing.

This was also the first time when it really hit me that the problem wasn’t the lack of existence of reliable investment solutions in stock markets — the problem had been me all along. I had actually heard of Soros’s quote for eons by then, but simply never registered what it truly meant. If so, what other value investing lessons could also have slipped past me due to my naivety?

This was my first realization that I had blind spots (in the context of being an investor). From then on, I actively sought to see past them by simply subscribing to the advice of these investing legends in blind faith — at least until I could properly understand their wisdom. It was also when I took my first step towards becoming a true acolyte of the school of Graham & Doddsville.

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Benjamin Graham — Promises Safety of Principal

My next Eureka moment arrived when I stumbled upon Benjamin Graham’s aforementioned quote again at some point. Like the Soros quote above, I had come across it many times prior to that, but never really understood what it meant. It had simply remained a platitude to me.

Given my previously realized insight that the optimal investment approach was risk:reward asymmetry, I began to develop a newfound appreciation for risk management and to actively seek downside protection in my investments, as advocated by Soros’s quote above. Naturally, this would lead me to shy away from typical “growth factor” investments in favor of “value factor” investments — since the former couldn’t promise the same nature of downside floor which the latter could, by virtue of “value factor” stocks typically already being at depressed valuations. If you’re interested to learn more about this phenomenon, I discuss it in detail in the article below:

Now think hard about what Benjamin Graham’s quote above is actually referring to. What type of major asset class fulfills his first criteria: Promises Safety of Principal? It’s fixed income, right? When investing in fixed income, the most important criteria isn’t maximizing returns — rather it is to ensure that your investment principal will be redeemed at maturity no matter what, i.e. promises safety of principal. Benjamin Graham was simply advocating to look for stocks exhibiting the risk:reward exposure of bonds!

Of course, the immediate investment implication of this criteria is to invest in cash equivalent assets (e.g. time deposits or money market funds), where safety of investment principal is promised. This is where the aforementioned quote’s second criteria kicks in: Adequate Return. Obviously what is considered “adequate” is subjective — but if beating the market is the investment objective, then the automatic assumption is that one should invest in outperforming stocks.

However, the difference in following Ben Graham’s advice as opposed to the traditional stock investing approach is that the latter tends to prioritize seeking maximum returns, while giving little thought to risk management. In contrast, the former uses fixed income risk:reward as the acceptable starting baseline — and only allows incremental risk where sufficient return can be justified. This advice is also advocated by the CFA by the way, it’s just that very few practitioners actually listen to it.

The true magic of Graham’s quote came to me when I married it with my recent appreciation of Soros’s quote above. The key lesson of the latter was that in markets where survivorship bias exists, backward-looking perspective does not represent the full data set of risk:reward available to the investor at the point of investment, and therefore cannot adequately inform forward-looking strategy. In that case, the only responsible investment approach is a bottom-up strategy which accounts for all possibilities — and ensures favorable outcomes in all possible timelines (i.e. asymmetric risk:reward). If that was the goal, then clearly the promise of Safety of Principal in all reasonably possible scenarios becomeshs incrementally alluring.

This was yet another experience where I had come across a value investing quote many times before, but failed to truly understand the wisdom contained within. It further solidified my conviction that value investing could potentially help me become wealthy — if only I could unlock all of its secrets, which were hidden in plain sight.

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Warren Buffett — Never Lose Money

“Rule No. 1: Never Lose Money” — Warren Buffett

“Price Is What You Pay, Value Is What You Get” — Warren Buffett

As Buffett’s biggest fan, I’ve always heard the aforementioned two quotes being thrown around casually. But for the first few years of my investing career, I never really understood what they actually meant in real-life practice.

The Buffett aphorism “Rule No. 1: Never Lose Money” is immediately followed by a pithy “Rule No. 2: Don’t Forget Rule No. 1”. This makes for interesting soundbites in certain circles, but few people actually appreciate the deep-seated wisdom it is implying. Most people usually associate it with the rules of compounding, where for every percentage of loss experienced an investor needs to recover a greater percentage of gain in order to breakeven. Behavioral investors might associate it with the pain of loss being greater than the joy experienced from gain.

However, if you really think about it, Buffett’s “Rule No. 1: Never Lose Money” is intimately related to Graham’s aforementioned quote, which requires that an investment “promises Safety Of Principal”. In isolation and without context, it may be difficult to see where Buffett’s quote might be coming from; but when you pair it with both Soros’s adherence to asymmetric risk:reward and Graham’s affinity to fixed income levels of risk, you realize that Buffett is actually coming from the same place as them when he says “Never Lose Money”. They are all talking about the same thing.

One significant implication of Buffett’s Rule No. 1 relates to his affinity towards acquiring stakes in wonderful businesses at fair prices. Many investors mistakenly interpret this to mean buying wonderful business at any price — such as during the 2021 tech bubble, where this quote of his was often used to justify investments in admittedly wonderful businesses with entrenched moats; but at stratospheric valuations. It is crucial to recognize that simply buying wonderful businesses is not enough — Buffett’s immediate follow-up criteria is to buy them “at fair prices”, which ideally should possess the same kind of Margin of Safety (between price vs. value) as your average cigar butt stock.

This means that despite Buffett’s investment preferences switching from investing in cigar butts to investing in wonderful businesses, he never actually departed from Graham’s teaching of only making investments which “promise Safety of Principal”. This is backed by his own quote of “Rule No. 1: Never Lose Money”. Of course, it is certainly better to invest in wonderful businesses over cigar butts — but only when an identical or better Margin of Safety exists.

This brings us to another oft-repeated Buffett quote, “Price is what you pay, Value is what you get”. With the context of Margin of Safety above, it should now be easier to understand what he meant by it. Value investing is concerned with investing in assets which have fundamental value — which is distinct from the share price, which actually relates to the cost of admission to the business, rather than the return from it.

When making investments, there needs to be a sufficient gap between price vs. value (i.e. Margin of Safety) — with the immediate implication here being that the investor first needs to understand the fundamental value of the underlying asset, before using that as his anchor for investment decisions; rather than the share price. Of course, he does expect that efficient markets will eventually reward improving fundamental value, which results in higher share prices; however, the share price does not represent a consideration of a return nature to him — only the fundamental business profits do. Rather, his only consideration with regards to the share price is the price paid — which is of a cost nature. This is where the distinctions in Buffett’s quote starts to become more apparent — (share) price is what you pay, (business) value is what you get.

There is actually more to discuss about the “safety” aspect of Margin of Safety — but we’ll do that in the section below.

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Howard Marks — No Bad Asset, Only Bad Prices

Howard Marks is probably best known for his affinity towards exploiting market cycles in his book The Most Important Thing. While that certainly added significantly to my investing repertoire, it was the underlying more fundamental lesson about exploiting mispriced opportunities (amidst trough market cycles) which truly captivated me.

Howard’s quote above basically describes how the price at which an investment is acquired at actually matters more than the fundamental value of the asset, in determining the final investment return. While it is certainly true that stocks represent pieces of real businesses and possess fundamental value, the final investment return very much depends on the price at which they are acquired at. For instance, a company with a 20% ROE (fundamental business value) would only provide the investor with a 10% earnings yield (investment return) if it is acquired at 2x P/B ratio (price paid). I discuss the direct relationship between fundamental value and valuation in determining the final investment yield of a stock in the article below:

Let’s use a real-life example to illustrate. NVDIA’s valuation today sports a trailing PE ratio in excess of 100x — which implies a 1% earnings yield. Now of course, there are people saying that it can grow its earnings by 30% CAGR. However, that would still imply that it would take over 6 years just to catch up with the current 5% yield of a 3-month Treasury bill, or 9 years to catch up to the 10% yield of a stock trading at 10x PE. A more conservative 20% CAGR assumption would increase that to 9 years and 13 years respectively. Of course, it’s a bit more complicated than that since they all have different growth rates. But we are also all too familiar by now with how macro conditions can change overnight, and render our LT forecasts pointless.

Now consider an opposite scenario. Think about something like SEA Ltd, which I covered a month ago and is trading at roughly 13x normalized PE today — implying about 7.5% earnings yield. While SEA Ltd is certainly expected to grow by less than NVIDIA going forward, its much lower valuation gives it a sevenfold headstart over NVIDIA (i.e. 7% vs. 1%) — thus making it much easier to cross the threshold for attaining a decent investment yield (e.g. 15%).

Subsequently, the question to ask is — can the higher earnings growth of the more expensive stock justify its disadvantaged starting position? At the end of the day, what matters is not how wonderful the business is but how much it can yield — and if it takes NVIDIA 8 years just to catch up to SEA’s starting yield today, the investor really needs to ask if the uncertainty over such a long period of time is worth the risk.

Howard Marks is actually more well-known for investing in distressed debt rather than equities at his legendary firm Oaktree Capital. However, the valuation principle remains the same — many times, paying lower prices for lower quality assets can counterintuitively lead to higher final investment returns vs. paying higher prices for higher quality assets. And since stock markets tend to be somewhat efficient, there is usually a direct relationship between share prices & business value — which means that such opportunities actually do show up quite regularly:

This lesson is also implied by Graham in his following quote:

'The margin of safety is always dependent on the price paid. For any security, it will be large at one price, small at some higher price, nonexistent at some still higher price. '

This insight of Marks’s was especially revealing to me when I realized that it was expressing the same principle as the aforementioned quotes by Soros, Pabrai, Graham and Buffett:

• Firstly, an asset acquired at low prices fulfills Soros’s condition of asymmetric risk:reward — as it puts a natural floor on the downside, while still enabling 2x upside if for instance it was acquired at a 50% margin of safety.

• Secondly, that same natural floor would aptly fulfill both Graham’s and Buffett’s investment requirements to promise Safety of Principal and Never Lose Money respectively.

• Meanwhile, subscribing to Marks’s advice would still leave plenty of room for upside, simply by virtue of a reversion to the mean via self-correcting market cycles.

As we saw earlier, Howard Marks’s approach of seeking an appropriate Margin of Safety between price and value is also intimately related to Buffett’s quote of “Price is what you pay, Value is what you get”. But now with the added context, the connection between the two becomes much more apparent, right? They’re all talking about the same thing.

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Seth Klarman — Margin of Safety

“There is nothing esoteric about value investing. It is simply the process of determining the value underlying a security and then buying it at a considerable discount from that value.” — Seth Klarman

Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety. — Benjamin Graham

Seth Klarman is best known as the founding fund manager of Baupost Group, and the author of the bestselling book Margin of Safety. The latter’s namesake is also what Klarman has come to represent amongst value investing circles.

Given everything we’ve discussed thus far, I think there has already been sufficient explanation of this principle. However, I’d just like to draw your attention again to the “safety” part of Margin of Safety. So far, we’ve been mostly emphasizing the “margin” part of the phrase which is concerned with price vs. value — but that margin is also meant to provide “safety”, in terms of downside protection. This circles back to Graham’s quote above of an investment operation being required to promise Safety of Principal.

In conclusion, do you see how all of the value investors are just talking about the same thing? This is what Value Investing really means. And it is this which made me 100% convinced that value investing is the superior investing methodology for generating LT outperformance.

At its heart, there is true substance to the idea of buying something that is worth a dollar for 50 cents. And while there can be many different implementations of it — e.g. Buffett’s wonderful businesses or Walter Schloss’s cigar butts — at the end of the day they are all referencing the same principle. That’s what we call Value Investing.

At its essence, value investing simply involves buying something for less than its worth. Through the respective lenses and investment experiences of the different Teachers above, each of them independently came up with different ways to describe the same investment principle. Graham, Buffett, Soros, Marks and Klarman all independently crystallized decades of their experience into their own personal version of it, but at the end they’re coming from the same place. It is simply up to us to figure out what they actually mean — in order to unlock the secret to LT outperformance in stock markets.

The analogy I would draw here is Einstein’s groundbreaking formula of E = mc². Sure, anyone can reproduce the scientific results just by replicating his formula — but there are several orders of magnitudes in the difference of wisdom between a newcomer who just copies his formula, and Einstein deriving it himself from crystallizing decades of scientific experience.

This is how much wisdom is stored in these value investing quotes — and in their boundless generosity, they’ve shared it with us for free. All it takes is for us to be willing to take the time to truly understand what they mean, then we too can replicate their super-outstanding LT outperformance — just as a beginner scientist can replicate Einstein’s results simply by following his formula in blind faith.

By illustrating my personal investor journey as aforementioned, I hope it has given you some insight into how much value there is to unpack from these seemingly innocent and oft-repeated value investing quotes — and how much more there might be left to unravel. If your personal journey has led you to a different interpretation of the quotes above, I’d love to hear about them in the comments.

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