Value investing describes a framework we use to approach decision making. It is less about strict rules and more about setting grounding principles while also providing us with the proper attitude we need for long term success.

The success of value investing comes not because it is complex, but rather because it forces us to overcome the limitations that afflict other investors. Value investing allows us to act rationally, think objectively, control our emotions, and ignore the pull of the crowd.

Perhaps the defining characteristic of our style investing comes from our simple overarching objective: we seek to value assets and then buy them for significantly less than they are worth.

Hold that objective in your mind. We are very explicit in our thinking. We deliberately seek to understand a business, value that business, and purchase that business for much less than we think it is worth. We call the difference between the intrinsic value of the business and the discounted price we pay, the margin of safety. The larger the discount, the larger the margin of safety.

As part of valuing a business, we must understand how businesses make money and what allows some businesses to be consistently profitable over time. This is because as time passes competition will tend to challenge a business’s ability to earn high returns on its capital. Some businesses have distinct features that protect its profitability and allow it to earn high returns on its capital for long periods of time. When this occurs we say the business has a durable competitive advantage or an “economic moat.” When we are talking about durable competitive advantage or “moats” we are talking about structural characteristics that are inherent to the business and its industry that allow it consistently resist the drain of competition.

Therefore, at the risk of taking a lot of the mystery out of investing, successful investing requires the mastery of two things: 1) seeking out great businesses with high returns on invested capital which involves a deep understanding of durable competitive advantage and; 2) valuation—determining what a business is worth and ensuring we are investing only at a large discount which we call the margin of safety.

Although value investors think of stocks as the ownership interest in a real business, the stock market provides the opportunity for this fact to get lost on other investors. Stock market prices fluctuate to a much larger degree than warranted by business fundamentals because in the short term stock market prices can be dictated by emotion, investor reaction to events, speculation, etc. Stock price fluctuations tell us a lot about other investors’ psychology and behavior but we ignore stock price fluctuations for the purposes of determining how we should think and act. Value investors are concerned with the value of the underlying business and not concerned with trying to predict the feelings of other investors.

Therefore, value investors do not allow the price fluctuations of the market dictate their decision making. The moves of the stock market are met with a healthy degree of skepticism and we never forget that in the short run market prices are subject to the whims of ever changing investor moods. In short, value investors believe the market is there to serve us not to instruct us.

Most investors get sucked into the fluctuations of the market and their behavior begins amounting to nothing more than trying to predict which stocks will go up and which will go down. In practice this usually amounts to simply doing what other investors are doing.  In other words, in the short run the market tends to act like a popularity contest in which the stocks that go up are the one’s investors are currently most enthusiastic about. However over the long run the substance of the company is what actually matters. The economics of the business win out over the subjective feelings of investors. This is why value investors have much longer investment horizons than other investors.

If we buy only when other people are buying and sell only when other people are selling we should expect results that are no different from the crowd. By thinking and acting like other investors we will achieve, by definition, only average results.  Great investors must have the ability to act independently and sometimes directly contrary to the crowd.

There are times when the emotions of the crowd create a large discrepancy between the value of the underlying business and the stock price in the market. These are the opportunities we are looking for as value investors. Our primary objective is to value a business and then purchase it for substantially less than it is worth.  The fluctuations in other investor’s moods provide the discounted prices we are looking for. But we will not be able to benefit if we are caught up in the same irrationality as the market.

We must be able to think objectively and independently. Therefore, success lies in the ability to control our own emotions as well as eliminating the influence of other investor’s emotions. We do this by focusing on the value of the business itself for our source of return. We seek to understand a business, value the business, and purchase that business for substantially less than we think it is worth.  This framework allows us to act rationally even under the most difficult circumstances.