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The Value Investing Philosophy

An interview with Charles H. Brandes, Chairman of Brandes Investment Partners

Imagine someone giving you a formula for investing that has not only withstood the test of time, but that has also been the foundation around which Warren Buffet, one of the world’s savviest investors built his empire. Originally developed in the early 20th century by Benjamin Graham (Buffet’s mentor) and David L. Dodd, value investing is defined as buying shares of a company at a price that is substantially lower than the company’s fundamental or underlying value. The result is the margin of safety, which represents the discount between a company’s stock price and its intrinsic value as obtained by a valuation methodology.

Charles H. Brandes adopted the value investing philosophy, creating an investment powerhouse that made him one of the most successful and respected asset managers in the industry. For someone who currently manages more than $50 billion, you would think he relies on a tremendously complex investment strategy. As we discuss during this interview, the success of Charles Brandes lies in concise value investing principles.

What was your experience meeting and talking with Benjamin Graham versus just reading his books?

I studied his books in graduate school, and when I started training to become a stockbroker we had to read Graham. Everyone else who read it thought it was a bit old fashioned, so stodgy. This was a new era here, you had IPOs and the fast food stocks were supposed to take over everything. I didn’t know any better. So along came the end of the 1960-1970 bull market. All these new concepts were kind of wiped out and the market was down 40 to 45 percent. That was the greatest experience I could have. Woke me up!

After that severe bear market is when I met Graham. He was living in La Jolla and by that time he was fully retired. He had a lot of other interests besides just investing. Always active and busy, he was interested in classical literature, languages and all sorts of things. To be able have some interaction, talk and then re-read his concepts was magical.

It’s somewhat similar to what Warren Buffet said years ago: “It either becomes a light bulb in your head and you automatically adopt it and say, this makes a lot of sense, and this is the way real investing should be, or you just never get it.”

After going through that severe bear market and talking to Graham, I got it even more, and I totally adopted his principles at that point. So it wasn’t just meeting Graham, it was a combination of the bear market, meeting Graham and looking at his philosophy that brought it all together.

What didn’t you learn from Benjamin Graham?

I’ve never gotten that question before. Here’s the thing about Benjamin Graham. He started on Wall Street around 1917 as a runner, so he went through so much that there really wasn’t much he didn’t cover. We really didn’t discuss investing outside the U.S.; this was an uncommon practice in his time. But when you really come down to the basic principles of what is true about investing, it doesn’t matter what country or market you’re in, his ideas still apply.

What has San Diego meant for Charles Brandes?

It’s obviously good to be away from the day-to-day speculative activity that happens in New York. The other advantage is the weather is much better here. I’ve always thought it made sense to think about the whole world, not just the U.S. I don’t think if I were in Los Angeles or New York, it would be any different.

How can the average investor identify a value stock? What do you specifically look for?

It’s totally divorced from the stock market. It was the first chapter in (Benjamin Graham’s) “The Intelligent Investor: Investment vs. Speculation.” Many people are actually confused between investments and speculation. Graham said any kind of short-term thinking is not investing. You shouldn’t worry about near-term earnings, stock market direction or interest rates. That’s just speculation on short-term events, but they really don’t have any fundamental effect on how a business creates wealth over time for its owner. He said the only time you ever want to look at the stock market is when prices fluctuate down to a large margin of safety: the margin of safety principle. It’s simple, it’s basic.

Human beings continuously have a problem thinking in terms of a long-term investment. Graham always said: “You think about this as actually owning the company on a private basis, you don’t think about it as owning a stock that is trading. You think about the fundamentals of a company, the historic fundamentals of the industry and how that company produces wealth for its owners over the long term.” It all boils down to John Burr Williams’ basic fundamental principle of discounted value of all future cash flows. That’s what true investing is.

What’s been your particular experience of identifying investment opportunities within different economic cycles?

You always use the basic concept of the margin of safety to estimate the level of the market and the values that are out there. In March 2009, when we looked at our portfolios, we were seeing 50 and 60 percent, and in some instances 70 and 80 percent discounts from that intrinsic value at the bottom of the market and that’s about the biggest discounts I’ve seen in my career. Everybody was thinking the whole world was going to explode. I would look outside my building toward the freeway and there were still lots of trucks going by, people were still working and doing things. That’s all I really needed to know and that there was a discount. Today, we are still seeing good discounts. In 2006 and 2007, our margins of safety were getting low. That kind of gives you an indication there weren’t as many bargains around. Our margins of safety at that point were 20 percent or less.

The demise of Lehman Brothers, the Madoff scandal and worldwide credit markets completely frozen. What’s going through your mind as you watched the unraveling of the recent financial crisis on CNBC?

We don’t watch CNBC and it really wasn’t that much different from the bear market of 1974. We didn’t have quite the credit crunch, but many companies went bankrupt and over-leveraged institutions were wiped out. In different ways, it was almost as bad then as what it was in 2008-09. So, from an investment standpoint, I was calm since I had been through this before. I was certain we were going to have a major rebound, but you never know when it’s going to happen. The 1974 bear market bottomed out in December, and then we had a similar bounce in 1975. Market was up around 75 percent. This time, we had the same bounce; the market was up 80-88 percent within the next year. It wasn’t all that different, and therefore when I get in the middle of a recession or a bear market, it’s like we are doing the same old things again, so as long as you think long term, you’ll be fine.

Do you think hedge funds are cannibalizing value investors? Is there room for both?

There is room for both. Hedge funds are regularly much shorter term oriented, and if you are short-term oriented, you are obviously speculating. They’re trying to take advantage of market anomalies, and it’s a market type operation. They’re doing a zero sum game, and we’re a positive sum game.

What are your views on current fiscal and monetary policies and the ongoing debate in political and economic circles about austerity versus stimulus?

It’s not sustainable. Keynesian doctrine doesn’t make any sense. I suppose in the very short term, spending will have some effect. But as we think long term, that’s not the right thing to do. Printing money and government spending is not how you create a strong economy. It doesn’t make any sense.

In 2010, the financial crisis had spread to Europe. This important block of developed countries was hit hard. What is your vision of the euro and the European Union as a whole?

We don’t make investment decisions based on where we think the euro will go or if the European Union is going to break up. We are just not going to do that. Value investors don’t make investment decisions based on top down considerations. We just go by the margin of safety and look at particular businesses.

While developed nations run the threat of stagnation and emerging markets grow, how do you choose what countries to participate in and what strategies are you applying to gain exposure to companies abroad?

We have been buying emerging market stocks directly for over 25 years and our portfolios hold U.S. companies with overseas exposure. Our main criterion again is the discount margin of safety that exists no matter what industry, location or currency. What matters is the price of shares compared to what the long-term intrinsic value has been. We don’t try to forecast currencies. That’s really speculative and in my estimation, impossible. If we are in a country where there is some mismanagement, questionable accounting or political tensions, we will take that into account and therefore put a smaller value in comparison to book value, earnings and free cash flows.

As a consequence of the 2008 crisis, significant flows of money have been put into gold investments. How should a value investor approach gold?

Not at all! You would look at the value of gold mining companies. Gold does not create wealth. Gold is storage of wealth perhaps, especially in periods where you have governments printing money, but it’s not a wealth producer.

What event in your professional life has given you the most valuable lesson?

The bear market of the early 1970s.

What’s your favorite reference or bedside table book?

“The Intelligent Investor” by Benjamin Graham.

What advice would you give to the average investor?

Forget about the stock market. Think fundamental business value over the long term.

Where are you focusing your philanthropic activity and what is the objective behind this?

It’s fairly well-diversified. In fact, one of the areas is education and scholarships because just like value investing, it’s long-term thinking.

Finally, what would you want to remain as the Charles Brandes legacy?

Having a high-quality firm that’s still independent and continues to do quality work for its clients.

Charles H. Brandes, CFA
Charles is chairman of the firm’s five-member Executive Committee where he shares responsibility for driving strategic decisions and monitoring implementation of the firm’s vision and objectives. He is also a member of the Investment Oversight Committee which monitors the processes and activities of the firm’s investment committees. Prior to founding Brandes in 1974, he became an acquaintance of Benjamin Graham, widely considered the father of the value investing approach. Charles has also authored a book on value investing. He earned his B.A. in economics from Bucknell University. He has 42 years of investment experience.

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