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Hello and welcome to a new video from Investing from Scratch. Did you know that the annualized return of the Magellan Fund, managed by Peter Lynch for 13 years, was 29 percent? Did you know that the annualized return of Warren Buffett through his publicly traded holding company, Versus Hathaway, has been 20 percent since 1965?
Did you know that the annualized return of Charlie Münger when he managed his hedge funds for 13 years was also 19.8 percent? They all have something in common: they became millionaires with the same investment philosophy, which is value investing. In this video, I'm going to explain what value investing is and what its six main principles are.
Welcome to Investing from Scratch, the channel that will show you all the secrets of professional investing. Before we begin, let me briefly explain its history. The origins of this investment philosophy date back to 1928 when Benjamin Graham and David Tot began teaching value investing as a subject in the Columbia Business School: This investment philosophy has been popularized primarily by Warren Buffett, a star pupil of Mr.
Graham, but it is also advocated by other great investors such as Said Clark Man, Peter Lynch, and Joel Green Black. Value investing, or value investing, can be defined simply as acquiring something below its intrinsic value, or real value. What does this mean? This is a question my clients frequently ask, with the sole intention of understanding how we invest their savings.
Let me explain with the same example I always use. Imagine for a moment that we are going to buy a house. We have already decided on the street, and now our real estate agent is going to show us three options. These three options are located on the same street and designed by the same architect, with the same decor and specifications, so the three houses are exactly the same.
The first two houses we visit are priced at $500,000. However, when we visit the third house, the agent informs us that it is priced at $250,000, that is, 50% less. The first two houses we visited, and you might wonder why this third house is worth 50% less. People explain that they're offering it for a reason: there are temporary neighbors who cause a lot of noise and disturbance, but they'll be leaving in a year or a year and a half.
So, knowing the prices of the first two houses, we can calculate the true market value of this third one, which should be 500,000 euros. We know the market discount for this temporary problem is 50%. Buying this house would be applying the philosophy of value investing. We're buying something below its true market value, and it's very likely that in a certain period, this house will recover its true market price.
As Mr. Graham says, price is what you pay, but value is what you get. This example of value investing might seem absurd and irrational, but it happens daily in the stock market with companies. A fool and his money don't stay together for long. Subscribe to the channel and don't forget to activate notifications so you don't miss any of our videos.
What are the... Six main keys to value investing: The first key is the margin of safety— how much can I lose on this investment? When we make an investment, our brains unconsciously focus on how much we'll gain, only showing us the positive side. However, in value investing, controlling our emotions is fundamental, and we must be cautious.
It's more accurate to focus on how much we can lose on this investment. This way, we limit the downside or loss and don't limit the gains. As mentioned, we should try to acquire assets at a price below their intrinsic value. The difference between the market price and its intrinsic value is what Graham defined as the margin of safety, and this is probably the main pillar of the value investing philosophy.
But be careful; to this principle of Mr. Graham, we must add something very important that Philippe Richert explained many years later: we shouldn't just buy assets that are cheap or seem cheap, but we must also analyze them and ensure the quality and growth of the business. The next key is the circle of competence.
This is another pillar described in... Graham's book, *The Intelligent Investor*, explains that we should only invest in what we truly understand. When making any investment in the stock market, we must know everything about the type of business we are buying. We must feel completely confident and knowledgeable about our investment and not be swayed by market trends we don't understand.
This idea that we should only buy businesses we know leads us to the next principle: we buy percentages of businesses. As we also saw in the previous video, when we buy a stake in a company, we automatically become owners of the business and must have an entrepreneurial mindset. Just as in our daily lives, we wouldn't invest in a business where our partner wastes the money generated on things that don't produce any kind of return or where the business is burdened with more debt than it can afford, it's the same in the stock market.
We should only invest in businesses that are high- quality and well-managed. The next principle we're going to look at is that of Mr. Market. Mr. Market is a key concept in market psychology. As we saw in the previous video, it 's a personification of how the stock market works, and Mr. Market is the character who replaces what we often call "the market." We will only find this concept in...
The stock market doesn't exist in real estate or private equity, since in these last two cases the parties involved in the transactions are usually few, typically two, and both are highly informed, so there are no inefficiencies when setting the value or price of the asset. As intelligent investors, our strategy should be to know how to value companies as if we were the owners and have the composure to sell our shares to Mr.
Market when he's in a good mood and pays us a high price, and buy those shares back when he's angry and willing to sell them to us below their real value. Being disciplined with this concept seems really simple, but I assure you it's one of the most important and at the same time complicated things to achieve in the world of investing.
The next key is the long term. The long term is another fundamental aspect to becoming a successful investor. I've heard hundreds of gurus offering investment methods that guarantee you'll get rich in the short term. Honestly, and from my professional experience, those methods—like " balloon investing"—are obviously not suitable for everyone.
If you're not able to hold a stock for 5 years, then... I'm sorry, but this isn't the place for you. Most people have the wrong mindset and look for quick rewards. It's different here; it requires discipline, hard work, and a lot of patience— qualities that not everyone has or is willing to cultivate.
Therefore, to succeed in investing, it's essential to train our minds and have a lot of patience, since we don't know when Mr. Market will decide to prove us right. As an example, let's look at the following comparison. In this chart, we see the best and worst returns of the S&P 500 for different time averages.
The red line shows the best performance in a year, and the maroon line the worst. As we can see, the fluctuation over a year is considerable, with the best year showing a 60% return and the worst -40%. However, as I explained, if we have a long-term mindset, we can see in the chart that the longer the period of time we are invested, the lower our chances of getting negative returns become, until they disappear.
If you look at the chart, after 15 years of being invested in the S&P 500, our return would be at least between 3% and 4% annualized. But remember, this is... For the market average, we will beat that market, and if we are able to select the best companies within that index, our return will be considerably higher, and we certainly won't need a 15-year period to guarantee positive returns; we will surely achieve it in less time.
We must make the long term our best ally. The last key is compound interest; it is probably the greatest secret to wealth and one of the key concepts of investing. As a curious anecdote, they say that Mr. Einstein was once asked what the most powerful force in the entire universe was, to which he replied, "Compound interest." One of the ways to make the long term our ally is to apply this concept in the world of investing.
It is also known as the snowball effect because it's very simple. Let me give you a simple example so you can see the power of this concept with little capital. Imagine that today you start investing your capital, and that this initial capital is ten thousand euros, and you also realize that you will save one thousand euros annually, which is equivalent to a little over 80 euros per month, and you will also reinvest it month by month.
The investment strategy you will use is... It will be based on a mix of funds, stocks, etc., obtaining an average return equivalent to the historical return of the American stock market, which is approximately 8%. After ten years, you decide to check how much capital you have. The result is 37,123.74 euros.
You have already accumulated a capital gain of more than seven thousand euros. Perhaps it doesn't seem like much, but since we are good investors and you know the six principles of investing well, and of course, you don't forget the chapter on compound interest, you know that you must continue investing so that the snowball gets bigger and bigger.
If we are patient, we don't touch that money and wait the average number of years of a person's working life, which is approximately 35 years. The result is considerably different; we will have built our own retirement, which will be equivalent to 333,955.59 euros. There are two pieces of advice that I always give my clients to enhance this effect of compound interest.
The first is that you try to invest only those savings that you don't need to live on, and the second is that you make all the periodic contributions to that capital. In this way, if you apply these two concepts Boost the momentum of that snowball; these have been the six principles of value investing.
If you want to be a successful investor, you must have them well integrated into your investment strategy. With them, you will be able to build very robust investment portfolios with a wide margin of safety and, at the same time, with a return above the market average. If you want to learn more about each of them, don't worry, leave in the comments which ones interest you most, and we will analyze them in depth in future videos on the channel.
Greetings, and until the next video, subscribe to the channel and don't forget to activate notifications so you don't miss any of our videos.
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