After making the case that margin of safety is the central concept to investing we anticipate a hypothetical conversation could go like this:
CHALLENGER: You are clueless, aren’t you? Value investing is finance 101. You write a blog on finance and you don’t know that?
F27: We’re aware of the phrase value investing.
CHALLENGER: Great. Then, you must also know that Ben Graham is the “father of value investing.”
F27: We are aware. Also, Shaq is the “father of the stepback three.”
CHALLENGER: What are you talking about? Shaq barely shot threes; he shot just 22 three pointers over his entire career! He made one, and that was not a stepback three.
F27: You are right, and as far as we are concerned, Ben Graham, never said value investing, either.
CHALLENGER: ???
Can you blame the challenger for being shocked? A quick look at the two masterpieces written by the “father of value investing” is a great start to understanding where that train derailed.
You browse through the latest edition of Security Analysis, and it not only greets you with “The classic work from the ‘father of value investing,’” but it also comes with the subtitle “With new and updated contributions by James Grant, Roger Lowenstein, Howard Marks, And Other Top Voices in Value Investing.”
You keep browsing and come across The 75th Anniversary Edition of The Intelligent Investor, which not only greets you with “Graham’s timeless philosophy of ‘value investing’ helps protect investors against common mistakes and teaches them to develop sensible strategies that will serve them throughout their lifetime,” but it also comes with the subtitle: “The Definitive Book on Value Investing.”
We’re here to reveal a hidden truth about this value investing misnomer. You need to ignore everything you’ve heard and read on value investing up until this point, digest the facts we are about to lay out, and then be open to the possibility that this has just been a colossal misunderstanding; a myth that not only survived but has thrived well beyond its expiration date.
Perhaps the more important question is why should you care? The word “value” is redundant, but what is being described (value the asset, compare price to value, buy if it is cheap enough) is still investing right? What’s the harm?
The problem is this: The moment redundant words become mainstream and an entire category is diminished to a subset, the pretenders start moving in, claiming the same privileges. We told you the Sultan’s Tale before, let’s hear it again, shall we?
What does it have anything to do with finance? Think of all possible trades like shapes. Equities are one asset class, so stock trades are a subset of all trades, the same way rectangles are a subset of all shapes. Within the subset of equities trading, there is yet another subset: trades that are investments. Remember, investment requires two things: i) a cash-flow-generating asset; and ii) margin of safety.
Stocks are cash-flow-generating assets regardless of whether they pay dividends or not. You are the owner of the underlying business, and thus you have a claim on the cash flows the business will generate in perpetuity. Dividends are nice, that means you can access at least some of the cash flows on a regular basis, but their absence does not mean stocks are worthless. Dividends or not, a percentage of the cash flows will always be yours as long as you own the stock.
Yet, for a stock trade to be an investment, one more thing is needed: margin of safety. That’s what makes a shot the right shot. So, investments are like squares, they are a special type of the broader category.
Once society relabeled investing as “value investing,” however, alternate finance was born. If there is “value investing,” people conclude, quite rationally, that there must be other types of investing. So, the concept of investing expanded and swallowed, first, all equity trading; in this alternate world, every stock trade became an investment. The lines between investing and speculation blurred, the exact same thing Ben Graham warned us against.
The trading universe is a very large space however, and speculation had no intention of stopping. Now that it conquered equities, it has continued to move in to fill the gap. In this alternate world, not just every stock trade becomes an investment, it’s even worse: every trade of any asset, crypto included, becomes an investment, causing the most profound issue of speculation being sold as investing.
So, we care and you should care too because today's youth is being fooled and they don’t even know it. It is my teenage daughter and very likely yours as well, who will end up thinking that one can invest in crypto. We have one shot to reverse the damage, otherwise we may lose all future generations.
