Is Warren Buffett's 'Value Investing' Dead?

Hey guys, welcome back to the channel! In this video, we're going to be doing a video talking about a popular topic at the moment. I've seen a lot of videos floating around talking about this. The topic is whether value investing is dead.

So today, we're going to talk about what value investing is, the different kind of value investing approaches that exist out there, and my personal opinion, which is definitely that value investing is not dead. In fact, I think it is alive and well, as good as ever before.

So first of all, let's talk about what value investing is. Now, really, when it comes down to it, I consider all investing to be value investing because at the end of the day, we're just trying to buy undervalued stocks. I mean, that's all investors approach. No investor goes in trying to buy overvalued stocks; that would be insane.

So I think that all investing really is value investing in some element. However, what people are usually referring to when they say value investing is really the approach that was first put down pen and paper by Ben Graham back with his book "Security Analysis" and then built on with "The Intelligent Investor." That's the approach that Warren Buffett kind of learnt and then took over and kind of made his own over time.

Now, when Ben Graham first kind of put this idea of value investing down onto paper, it was very different from the kind of value investing we see Warren Buffett do today. Ben Graham's approach has been referred to as kind of picking these cigar butt companies. Now, it's very, very different from what Warren Buffett does today.

So Ben Graham, he was looking for really ridiculously cheap companies—like really super low P/E ratios. To be honest, sometimes he didn't view companies as businesses; he kind of viewed them more as just a collection of assets that put together formed this company. But he viewed it more in the sense of, you know, if I buy this, it's cheap enough where if the company goes bust, then it could probably be broken up and sold off in its different parts, and I could still make money.

His approach wasn't to back these cheap companies that he believed had a great business behind them and were going to perform well and grow the next 10, 20, 30 years. His first kind of mentality was, "We'll make sure it's cheap enough that, you know, if all things went wrong and it got broken up and sold off, I'd still probably come out making money."

Then what he did after that is he talked about buying a massive diversified basket of all these different companies, so hopefully you come out with more companies that kind of rebound and regain some of their share price or regain some of their value. You have more of those companies than the ones that just fail miserably and go bust.

Now, in my opinion, that version of value investing? Hmm, that's not my cup of tea. I think that version is pretty much dead. But then what happened is Warren Buffett came along, along with Charlie Munger, and of course, they've been working together for so long. They took that kind of fundamental approach of finding undervalued businesses and built on it.

In fact, one of the most important things that they kind of changed about it is they put a lot more emphasis on finding businesses that you think will perform well into the future and grow. They put a lot more emphasis on the collection of assets that is the company—not just being a collection of assets, but being a functioning machine that can produce cash flow and that can grow over time.

That's really Warren Buffett's kind of thinking: there is value in a business that goes beyond the sum total of the assets that make up the business. And that's really the secret sauce of investing. Yes, you need to always look for good prices. I'm mad at what? But overall, base your valuation on the business operations as opposed to the assets that make up the business.

Now, I think that version of value investing is certainly alive and well. But a lot of people recently have been looking at people like Warren Buffett and have deemed this value investing approach to no longer be effective. They're calling it dead, right? They've because essentially they're looking at what Warren Buffett has done over the last little while.

So, for instance, Warren Buffett, in the last five years, the S&P 500 has gone up, I think, 46%. And for a lot of that time period, Warren Buffett really hasn't been doing very much. He's sitting in record high cash levels for Berkshire Hathaway of 130 billion, and if you look at this amazing, tremendous period of stock market returns over the past five years, he really hasn't made any major investments.

He's largely missed out on that run-up by sitting on the sidelines to a fair degree. I mean, the last big major investment he made was in Apple, and that was back in 2016. Now, the straw that kind of broke the camel's back here was recently when we had a 35% drop, sudden drop in the stock market. And, you know, businesses were feeling the squeeze; there were bargains all around us. You know, there was a global shutdown.

Then Berkshire Hathaway holds its annual shareholder meeting. Warren Buffett comes out and says that over this time where the stock market has gone down by 35%, he's been a net seller of stocks. A 35% drop-off in the stock market, and Warren Buffett is basically doing nothing. In fact, he's selling! That seems like the opposite of value investing. Investing is all about buying low and selling high. Why is it that during a 35% drop-off in the stock market, Warren Buffett has decided, actually, instead of buying low, I'm just gonna sell?

So for these reasons, you know, a lot of people are saying that Warren Buffett's lost his touch, value investing is dead. I mean, he's just making all the wrong moves. But to be honest, I definitely don't think value investing is dead.

I actually defend Warren Buffett with how he has acted with his investing over the past five years or so, and I want to kind of take you through a couple of points to explain why, in my opinion, Warren Buffett has actually done everything by the value investing book.

So firstly, I wanted to address the most recent stuff: why Warren Buffett was a net seller of stocks despite the market going down 35%. And really, this just comes down to the fact that he decided he made a mistake and he decided to sell out of his investments in the four big US airlines.

Now, I do defend Warren Buffett's decision to sell out of the airline stocks, even though he probably would have made about a 50% loss on each position. The reason for that is when it comes to value investing, there are really two main parts of the value investing approach—overarching parts.

The first part is trying to find really great, wonderful businesses, and the second part is taking those businesses and only buying them when they're at margin of safety prices. So let's talk about that first step. To be successful in the long run as a value investor, you have to buy into fabulous, wonderful companies, okay? Rock-solid businesses.

And there's no doubt when we look at the US airlines, they are a very different company now from what they were six months ago, and Warren Buffett realized that. He actually spoke about this in the recent annual shareholder meeting for Berkshire Hathaway. Essentially, over the past six months, with the global shutdown, all air travel has been stopped.

These companies now have had to take on billions and billions and billions and billions of dollars of debt just to stay alive right now, and he recognizes that. Of course, taking on massive debt is borrowing from your future self, so there's going to be a period down the line where instead of the company having awesome profits and being able to reinvest into the business, instead of doing that, they're just going to have to take any money they make and they're gonna have to repay that debt.

That takes away from the upside of being a long-term shareholder. So that's the situation with the airlines. As we know, to be a successful long-term investor, we have to stay invested in wonderful companies, but we can't stay invested in mediocre companies or companies that put our money at risk.

From Warren Buffett's perspective, he thinks that over the past six months, the airlines have changed in a way that they're now no longer wonderful businesses. So even though he's taking a loss, it is better for him to leave those positions. If the company is no longer great, you just can't cling on to crappy companies no matter what the situation. If the company has turned into a crappy company, you have to get rid of it.

But then there's also the argument that, okay, sure, he was a net seller of stocks, but if you look at the conditions, there were plenty of businesses that did go on super sales, and he still didn't really buy anything. Like, yes, he sold a lot, but he still didn't buy anything. And I also defend Warren Buffett on this because there's a very important factor that we have to consider with Warren Buffett and his Berkshire Hathaway portfolio, and that is that Warren Buffett has $130 billion of cash ready to go.

So for a company of his size, he wants to invest 10, 20, 30, 40 billion dollars into a big opportunity at once. Investing little bits and pieces here in companies worth hundreds of millions or one or two billion dollars just doesn't help Berkshire Hathaway at all. It's like us seeing a 5-cent piece on the ground and picking it up because, you know, that 5-cent piece might turn into 7 cents one day. It's just not gonna be worth the effort.

So for Warren Buffett, he's only looking at really big companies. And when he invests, he likes to keep his position under 10% of the company's total shares outstanding. So what that means is that if he wanted to invest at least 10 billion dollars, say, then immediately he's only looking at companies that have a market cap of over 100 billion dollars.

If you look at the S&P 500, which contains the 500 biggest companies in America, there are only 60 companies in that list that have a market cap of over 100 billion dollars. And guess what? Warren Buffett already owns a few of them. So that's why Warren Buffett didn't buy anything major, even though the stock market went down 35%, because he says in his annual shareholder meeting that there simply weren't any good enough deals that were large enough to interest Berkshire Hathaway.

So it's worth remembering that this is a very different situation from what we're trying to invest. You know, thousands of dollars at any one time, we can basically pick any company that exists in the whole world, right? And, you know, whatever investment we make, we can still make great returns. But for Buffett, because of his size, he has to look to the really big companies to make investments that actually shift the needle for his company.

So that's the justification as to why Buffett really didn't buy anything major, even though the market went down 35% recently. But then furthermore, we've also got to look at the idea that, well, even over the past five or so years, the market has gone up however much—46% in the US—and Warren Buffett really hasn't done too much.

He's kept, you know, 30-40% of his money on the sidelines in cash, and he hasn't put that money into the market. He's currently sitting on record cash levels for Berkshire Hathaway of about $130 billion. By keeping his money on the sidelines, he has missed out on double-digit stock market returns, and that's just the market; that's just the average.

But here's the thing. We spoke about the two overarching key ingredients of successful value investing: finding great companies and only buying them when they're at margin of safety prices. Great companies can turn into horrible investments if we buy them at prices that are just too high, and that's why for value investors it is so important to use things like, you know, cap rates and owner’s earnings or discounted cash flow analysis to actually get a good understanding of what the company is worth so that we only buy it when it is undervalued.

So if you follow this approach generally, then what it means is that in periods of time where the stock market is really overvalued, the strategy actually restricts you. It protects you; it keeps your money out of the market, whereas in times where the stock market, in general, is undervalued, following that two-step approach—great companies and margin of safety prices—helps you get more money into the market.

So generally speaking, this two-step value investing approach helps you get money into the market when stocks are undervalued, but it protects you from putting your money into the market when stocks are really overvalued. Now, one of the easiest, best numbers to look at when it comes to checking whether the market is overvalued or undervalued is, of course, the Shiller P/E ratio.

Now, the Shiller P/E basically compares the share price of the S&P 500 to the average earnings of the S&P 500 over the past 10 years. So it is a cyclically adjusted P/E ratio or a Cape ratio. Now, on average, this number usually sits at 16.5, roughly there. And what that means is that investors are willing to pay sixteen times the average earnings of the last ten years of the S&P 500 as a share price.

Now, over the past five years, we can see that this number has consistently stayed above 25; currently, it's at 28.73. So on average, people are paying way more just to own these companies than what they normally would. So this indicates quite a substantially overpriced stock market.

Now, of course, there are always exceptions; there are always opportunities out there. But generally speaking, on the whole, when the market is really overvalued, the two-step value investing approach keeps us protected, keeps more of our money on the sidelines. Over the past five years, that is exactly what we've seen. We've seen a market that is very overvalued; therefore, the value investing approach that people like myself and Warren Buffett, you know, Phil Town, or whoever you like—all those guys—that's the reason that they've naturally been accumulating more and more cash.

Now, of course, the stock market could go up, down, or sideways. Even if it's overvalued, that doesn't mean it's going to crash; it could still go up, could go down, could go sideways. It's more likely that it's going to go down because, of course, it's really overvalued, but we don't know that.

So the value investing approach has actually been working perfectly over the last five years—the market's been really overvalued. So generally speaking, value investors have been keeping more of their money on the sidelines. It just so happens that despite the markets being overvalued, they've gone up and up and up and have been increasingly overvalued over the past few years.

Just remember, overall, the value investing approach only allows us to buy low so that we can sell high later on. It never allows us to buy high, and for that reason, that is why it has generally helped us keep money out of the market over the past five years, even though that means that we have missed out on the stock market gains of the last five years.

So overall, do I think value investing is dead? Absolutely not! The strategy of finding great companies and only buying them when they're at margin of safety prices—the value investing approach that people like Warren Buffett and Charlie Munger and Phil Town and Mohnish Pabrai—all of those guys use? No, this is absolutely the right investing approach to follow if you want to have success in the stock market over decades and decades and decades.

However, I can understand why people have been calling value investing dead over the past little while, just because we've been seeing such amazing stock market gains. But at the same time, the value investing approach has stopped us from sinking too much money into the market.

Overall, this story could be completely different. We could see, you know, the stock market drop by 50%, and then everyone will be saying, "Oh, value investing is alive and well once again," because now it’s an opportunity to get heaps of money back into the market and make really great investments to hold for a very long period of time.

So overall, that's my two cents on the topic. I definitely don't think value investing is dead; I just think at the moment, it's protecting us. So anyway, I'd love to hear what you guys think. Drop your opinions down in the comment section below, and if you're someone that is interested in learning more about Warren Buffett's style of investing, his value investing approach in a step-by-step manner—you just want it completely explained start to finish—then check out profitable links down in the description below.

Check out "Introduction to Stock Analysis"; that's the course that you want to check out for Warren Buffett's approach. It's an eight-hour course that goes through in depth all the things you need to know, all the things you need to look at to be a great value investor. So check that out if you're interested! Leave a like on the video if you did enjoy it or if you found it useful.

But thanks for watching, guys, and I'll talk to you soon! [Music] [Music] [Music]