The concept of value investing is well-known/widely discussed and a preferred investing strategy for many investors. Value investing is rooted in the difference between the price and value of businesses. It is also a form of strategy that does not work on impulsive trading tips. 

“Value Investing and Behavioral Finance” by Parag Parikh, sheds light on the relationship between ‘Value Investing’ and ‘Behavioral Finance’. In a way, he is communicating that value investing opportunities are the product of behavioral aspects of market participants. Some of the learnings from the book are:

Practice delayed gratification

Value investors practice delayed gratification. They reflect patience, remain steadfast on fundamentals, exercise significant discipline and emotional control on their investment matters. They are comfortable waiting for months and years for the right investment opportunities and having invested, they watch their investments bear fruits over a long time.

The fact of the matter is that investing is simple, but the industry has made it complicated. In the quest for instant gratification, finance professionals seem to have woven a web of complexity to confuse the investors. 

There is no ‘easy money’

Markets are most dangerous when making money in the market seems to be the easiest. A classic example is the IPO frenzy that has gripped investors in 2021. Retail investors have been participating in these IPOs in large numbers to make instant money on listing gains. However, IPOs are against the investor’s interest, as they are mostly offered to investors when they are willing to pay a higher and outrageous valuation in boom times. Value is found in the bear markets and IPOs are the product of the bull market. 

Be cautious in a crowd

When investors, politicians, academicians, market pundits, investment bankers, stockbrokers, analysts, company managements, foreign institutional investors, mutual fund managers all are optimistic, be cautious. 

Crowd psychology, when subject to excessive fear and greed, results in bull and bear phases from time to time. One needs to be a spectator of this phenomenon and jump to take advantage as and when the opportunity arises. As Warren Buffett said, “Become greedy when others are fearful and become fearful when others are greedy”. Value investing is a kind of contrarian approach to investing. This calls for not only a strong mind but a strong heart to enable one not to be swayed away by emotions.

Market success is based on knowledge

Investing becomes risky when it is based on market fancy; heard and without understanding. In the stock market, a small percentage of people end up being successful in the long run, whereas the majority of people, in spite of being successful in the short run, end up losers in the long run. Learn continuously. Build knowledge. Let your knowledge and experience compound over time.

Know the difference between good business and a good investment

Acquisition price determines your returns. Paying too much on speculative/cooked stories is foolish; buying at a low price reduces the risk and improves the chances of higher returns. One has to differentiate between a good stock and a good investment. A good business bought expensively is a bad investment. As Warren Buffett said, “Objective is to buy great businesses at a great price”.

At some point, the bubble bursts

Every new bubble has a new story justifying how ‘this time is different’ from the past bubble. However, the excesses are the same and, after every excess, there is contraction. Howard Marks of Oaktree Capital has written a wonderful book on the subject “Mastering the market cycles”.

The book also carries some interesting quotes from finance experts. Some of them are:

• “If everybody else is doing it one way, there is a good chance you can find your niche by going in exactly the opposite direction. But, be prepared for a lot of folks to wave you down and tell you are headed the wrong way” – Sam Walton
• “Worldly wisdom teaches that it is better for the reputation to fail conventionally than to succeed unconventionally.” – John Maynard Keynes
• “Those who do not learn from history are condemned to repeat it” – Santayana
• “You can think of investing as a long term journey with many starts, stops, changes of scenery and occasional bumps. We believe that you are much more likely to enjoy the journey, or at least endure it, and reach your destination safely if you know what to expect along the way. Your own psychology and ability to handle the emotional ups and downs of investing are likely to be important determinants of your long-run investment success.” – Tweedy Browne
• “If you can’t stand 50% paper loss on your stocks, stay away from the markets” – Warren Buffett
• “It is only when you combine sound intellect with emotional discipline that you get rational behaviour.” – Warren Buffett

The message from this book is simple – 

Rationality demands explanation, irrationality does not. Greed and fear drive people crazy. This craziness offers value investing opportunities to patient investors. Buy good businesses at the right price and have the patience to hold on to such investments for a long period of time. 

Always remember the wisdom of Benjamin Graham “Price is what you pay, value is what you get”. As an investor, you need to make sure that you don’t pay more than value i.e., pay as little as possible compared to sources of value from the business – Earnings, Cash flows and Assets.

About the Author

Parag Parikh was the ex-chairman of Financial Advisory Services Ltd. He passed away in a car accident in Omaha, Nebraska, US in Mar. 2018. To learn more about value investing, many of Parag’s videos are available on www.youtube.com.