The term “value investing” is used all the time, and more often than not, it’s used incorrectly.
When we tell you that we at Chess Capital are “value investors,” you have a right to know how we define the term.
In the beginning
The term “value investing” originated in the 1930s, in the context of the Great Depression. The pioneers were Benjamin Graham and David Dodd, both professors at Columbia Business School. In their seminal work Security Analysis (1934), they introduced the methodology that would later become known as “value investing.” The term itself only became popular later, but their theory laid the foundation.
In The Intelligent Investor (1949), Graham defined value investing as:
- Buying securities when their price is below their intrinsic value, calculated based on fundamentals (i.e., balance sheet, earnings, and cash flows).
- A strong emphasis on a “margin of safety“: only buying if the market price is sufficiently below the calculated intrinsic value, so that errors or unexpected events can be absorbed.
- A clear distinction between speculation (playing on price movements without fundamentals) and investing (buying shares because their value is higher than their price).
For Graham, value investing meant exactly what it still means for us today:
Systematically searching for undervalued shares based on fundamental analysis, with a focus on safety and long-term returns.
A shift to simplistic metrics
From the 1970s onwards, academic research into the results of investment strategies began to emerge. These studies used strict parameters to select shares. A well-known example is the study by Fama & French (1992), which defined “value” very narrowly: primarily low price-to-book and/or low price-to-earnings ratios.
Because they were measurable and testable across large datasets, “value” was often reduced to these simple multiples. As a result, “value investing” in practice became almost synonymous with buying cheap stocks based on simple ratios, without a deep analysis of business quality.
But there are some problems with that narrow definition. For one, book value has become a less relevant metric. Over the years, intangible assets (R&D, brands, software) have become more important, but they don’t appear on the balance sheet. This erodes the concept.
You can also question accounting profits. Often, investments are expensed rather than capitalized on the balance sheet. As a result, the price-to-earnings ratio, especially for fast-growing companies, can seem much higher (and the company more expensive) than it truly is. In large datasets, lower price-to-earnings ratios therefore tend to point to older, industrial companies.
Value investing’s image slipped, becoming more associated with “buying junk companies” rather than seeking intrinsic value.
The rise of growth and quality investing
In this century, two new concepts entered the scene. Investors and academics have increasingly emphasized that quality (e.g., high returns on capital, strong balance sheets, sustainable business models) and growth (sustainable earning power in the future) are an integral part of intrinsic value.
Modern approaches like “quality investing” and “growth investing” are actually just variations of Graham’s original ideas, but with different accents. Marketers often position them as opposing strategies. People love a simple, easy-to-understand label.
Graham himself would likely have included them under “value,” as long as the price is lower than the calculated value. As Charlie Munger once said, “All intelligent investing is value investing.”
What was once intended as a broad framework for rational investing based on intrinsic value has been narrowed down to a mechanical, narrow strategy due to the focus on a few accounting ratios. This makes it seem as if “quality” and “growth” are new or different things, when in fact they were always part of the real definition of value investing.
Patiently waiting for the “margin of safety”
Perhaps the most underestimated aspect is the psychological one: waiting for the right moment to buy.
With growth investing, you often hear people say: “The price doesn’t really matter because the company will grow into the price.” The danger here is that discipline weakens, and you end up paying too much for sometimes questionable growth in the distant future.
With quality investing, the risk is that you overestimate the quality of management, the business model, brand names, or competitive advantages. All of these things can quickly evaporate or turn out to be more trend-sensitive than they seem. This can tempt investors to pay a premium for quality companies.
That’s why for Chess Capital, the very first and most important mindset is “be greedy, pay less than it’s worth.” You can also translate this as:
- Don’t be overly optimistic about growth.
- Don’t overestimate quality.
- Calculate the company’s value in a moderate to pessimistic scenario.
- Wait until the price is well below your calculated value.
It’s only when you consistently apply this discipline that you can achieve above-average long-term returns without having to rely on lucky strikes.
These are the standards we hold for ourselves and for the value investing managers we select for the fund.