Intellectually simple, emotionally difficult

Value investing is intellectually probably the easiest form of investing

You look for something that is worth €1 and you only buy it if it is available for €0.6 or less, after which you patiently wait until the value and the price match, and then you take your profit. This is essentially the most simplistic way of representing value investing.

Of course, it's not just that, because you're also constantly looking for quality companies, and the way you determine value is always peppered with "estimations". Even if you make these estimations based on as much research as possible, they remain estimations. The future is uncertain, and therefore the evolution, value, and stock price of the company are also uncertain. In short, even as a value investor, despite all our analysis, you continue to place calculated bets.

Margin of Safety

That's why the 'margin of safety' is so important. It allows for a certain margin of error in your estimations, enabling you to withstand some setbacks and still come out with a profit from an investment. This is also the reason why value investing works so well.

It all sounds very rational and easy. "Buy low, sell high"... Is there any other way of investing? In theory, everyone wants to buy low and sell high, regardless of the investment approach they adhere to (except for short sellers, who do the opposite but follow the same mindset).

But as Yogi Berra said: "In theory, there is no difference between theory and practice. In practice, there is."

In other words, why isn't value investing more widely practiced, and why do people still buy high and sell low, suffering such losses?

Value investors often seem to be wrong

The answer is simple: as a value investor, it often seems like you're wrong most of the time.

Let me explain using a graph.

The graph above represents the price movement of a stock.

As value investors, we always look at the value of the stock (the green line). If the stock is trading significantly below this green line, we proceed to buy. If the stock is trading above the green line, or its intrinsic value, we proceed to sell.

But as you can see on the graph, this also means that for a significant portion of the time, it seems like we've made the wrong decision. For example, after our purchase "a", the price initially drops another 20% over the course of 6 months. During all that time, it seems like our purchase was a wrong choice. It's not pleasant to face a loss.

Then comes the rise; the market starts recognizing the value, and we steadily climb. After another 6 months, we surpass our original purchase price. Another 12 months later, we reach the selling point. We can sell with a profit of 60%.

But even after we sell position 'a', the stock continues to rise further, increasing by another 30% over 6 months before the decline begins again.

In the above example, it means that during a period of 2.5 years, it seemed like the choice for both purchase and sale was wrong for a total of 1.5 years. More than half of the time, it seemed like the value investor didn't know what they were doing.

The above scenario is typical for every value investor; they essentially buy and sell too early. The reason for this is simple: every value investor is aware that it's pointless to try to predict a bottom or a top; you'll never know them. Who can say in advance whether a stock will not continue to decline or rise?

Therefore, the value investor doesn't waste time guessing the price movements but rather focuses primarily on the green line, namely the intrinsic value. As long as this value remains steady and preferably rises, as in the above example, they are not concerned about the price fluctuations.

However, things change if we encounter the scenario below.

Here, too, the investor buys significantly below the intrinsic value (green line), but in this case, the intrinsic value is declining. As soon as the stock price rises above the intrinsic value, you should immediately proceed with selling.

Such scenarios also occur and are precisely what value investors try to avoid as much as possible. Once again, it's the margin of safety that you need to protect. If you can sell above the purchase price, all the better; if not, you have to sell at a loss before the value of the company reaches zero.

Keeping these graphs in mind, especially the green (value) line, will help guide you through many market storms. You shouldn't view price movements as losses in your portfolio; this is merely volatility.

The real loss is the permanent loss of capital, namely when the value declines and you are forced to sell. That's why we also consider the quality of the company.

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