Why the usual criticisms don't apply to the exhaustive statistical framework of Warren Buffett's mentor, Benjamin Graham.
Criticisms and Responses
Given below are some criticisms of Value Investing stock screeners, and the reasons they don't apply to genuine Benjamin Graham stock screeners.
1. Standardization
Criticism: Value Investing stock screeners force data into a specific standard.
Response: Regulatory authorities require standardized reporting of financial data, for good reason.
If companies were free to report data any way they wanted to, accountants would be able to make any company look good and there would be no way or comparing two companies against each other.
Since an investor's interest in all stocks is the same — to be profitable investments — a good financial analysis should be using the same standardized data (such as GAAP data) to evaluate all stocks.
2. Comprehensiveness
Criticism: Value Investing stock screeners use misleading data such as P/E ratios.
Response: Applies only to superficial screeners.
A lot of what passes for Value Investing today is the deceptively-named Deep Value Investing, which is actually a very superficial application of Value Investing principles.
Graham's exhaustive framework has nearly seventeen checks and balances. The framework requires checking for three, five, and sometimes even ten years of earnings; and up to twenty years of dividends.
3. Expansiveness
Criticism: Value Investing stock screeners ignore off balance-sheet items.
Response: Again contradicts the reasoning behind regulation.
Not considering off balance-sheet items again contradicts the fundamental reason why regulatory authorities require standardized reporting; so that all companies have a level playing field.
4. Reliability
Criticism: Value Investing stock screeners use financials that may not be timely.
Response: Interim financial statements are unaudited and therefore unreliable.
When you're putting your hard-earned money on the line, It's more important to use reliable data than to use the latest data.
5. Rigor
Criticism: Company specific events can invalidate Value Investing parameters.
Response: Real Graham Value Investing is a comprehensive system of checks/criteria and balances/diversification.
Standardized Reporting
There are only three kinds of financial data for a company when it comes to investing.
- Standardized annual data.
- Non-standardized interim data.
- Inside information.
The second is unreliable, and the third is downright illegal. Only the first can be reliably used for investment analysis by the average retail investor.
Using Interim Data
There are professional investors who work on Special Situations using interim data. However, employing such strategies successfully requires decades of experience with primary Value Investing techniques.
Special Situations Are Unverifiable
GrahamValue's data mining algorithms apply the seventeen rules for Defensive, Enterprising and NCAV (or Net-Net) investment to all listed stocks. GrahamValue's screeners then allow users to filter the stocks based on the results of these algorithms.
Users are shown both the results, as well as the rules used to arrive at the results.
This is a far more reliable process than using a manual Special Situations analysis done by someone else.
There are no specific rules for Special Situations, and there is no way for an investor to verify a Special Situations analysis; unless the investor is a professional and did the analysis personally.
Value Is Inherently Quantitative
Graham stressed on the importance of using quantitative — or statistical — methods in making investment decisions on numerous occasions.
"Some of the best known [Financial Services] — such as Moody’s Investment Service and Standard & Poor’s — are identified with statistical organizations that compile the voluminous statistical data that form the basis for all serious security analysis."
Benjamin Graham, Chapter 10: The Investor and His Advisers, The Intelligent Investor.
"The first, or predictive, approach could also be called the qualitative approach, since it emphasizes prospects, management, and other nonmeasurable, albeit highly important, factors that go under the heading of quality. The second, or protective, approach may be called the quantitative or statistical approach, since it emphasizes the measurable relationships between selling price and earnings, assets, dividends, and so forth... In our own attitude and professional work we were always committed to the quantitative approach."
Benjamin Graham, Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor.
"For the enterprising investor this means that his operations for profit should be based not on optimism but on arithmetic."
Benjamin Graham, Chapter 20: “Margin of Safety” as the Central Concept of Investment, The Intelligent Investor.
Value Investing is therefore essentially a highly statistical exercise that requires a strong capacity — or the right tools — for working with numbers; especially using data that is standardized and publicly available.
In fact, as Walter Schloss wrote in his reminiscence of Graham [PDF], the department engaging in Security Analysis was originally known as the Statistical Department.
Therefore, the most efficient way for a regular investor — without special access — to apply Value Investing principles comprehensively today is to use a dedicated stock screener.
By Quants For Quants
Graham repeatedly emphasized that investors act like businessmen, and not speculators or gamblers. Graham's Risk Analysis Framework helps ensure a measurable Margin of Safety — that is both qualitative and quantitative — in one's investment decisions.
Using GrahamValue to apply Graham's framework ensures that your investment research is thorough, without being tedious. Instead of pouring over subjective written analyses, you now perform objective due diligence over large volumes of data and get accurate results immediately.
Having all relevant numbers accurately calculated — and presented in a structured manner — can greatly aid an investor in making the right decision. So you won't see any colorful graphics or story stocks on GrahamValue.
What you'll see instead is powerful software, that does serious number crunching.
Two Types of Critics
All disruptive advancements — especially technological — are met with resistance. Sometimes, the criticism is genuine; or simply because human nature is often suspicious of change.
But sometimes, the criticism is from the entrenched establishment with a conflict of interest; because it finds its outdated or incompetent ways of doing things threatened.
Deep Value Is Not Value Investing
Value Investing has become completely muddled with the so-called Deep Value Investing, which actually involves very superficial analysis and has nothing in common with Value Investing at all. Bargain stock hunters have trivialized what used to be an encyclopedic investment framework.
True Value Investing — which includes checking for quality and growth — is now almost a lost art.
Buffett on Graham
For The Average Investor
Buffett explains how Graham didn't want to do anything that a reader of his book couldn't do.
Most Successful Framework
Buffett explains how no other framework has been as successful as that of Graham, at the Berkshire Hathaway 2005 Annual Shareholders Meeting.