“If no forces interfere with the process of entry by competitors, profitability will be driven to levels at which efficient firms earn no more than a ‘normal’ return on their invested capital. It is barriers to entry, not differentiation by itself, that creates strategic opportunities.” – Bruce Greenwald.
Takeaway: Assorted thoughts on value investing from Professor Bruce Greenwald.
Columbia Business School has a fantastic value investing program, and one of its key leaders is the legendary professor Bruce Greenwald. Over the past few years, I have had the opportunity to hear him speak several times at different conferences and panels, and his thoughts on value investing have greatly impacted my thinking. I strongly recommend that you read this book from him if you have an interest in stock investing.
Some Principles from Bruce Greenwald
- Every time you buy a stock, somebody is selling that stock to you. Only one of you is right, because investing is a zero sum game. It is important that you think about why you are right and why the other person is wrong in this case.
- Look in areas of the market where you are more likely to be on the right side of the trade. These places include looking at small stocks which are often ignored by many investors, or specializing in a particular area (i.e. insurance or industrial companies) so that you have more knowledge than other people in that area.
- Stocks that have performed very well in the recent past (i.e. the last few years), tend to be overvalued on average. Investors always dream about getting rich quickly, so they tend to overpay for stocks that are “hot”.
- In contrast, investors tend to ignore disappointing stocks that are down a lot because they think the stock is a “loser” that will never go up.
- Humans don’t like uncertainty. When people think an investment is a winning or losing one, they believe in that for sure and exaggerate the probabilities. Therefore, they think that a winning stock will for sure stay a winner, and a losing stock will for sure continue to decline in price, even though the probabilities are much lower in both cases than most investors believe.
- Greenwald believes that the most important competitive advantage is barriers to entry – the factors that prevent another company from taking your business. These barriers could be a great brand, a low-cost structure that is sustainably below competitors, a great location, etc.
- When a company grows, it only creates value for shareholders if the additional capital the company invests to grow earns an attractive return on that capital (we will discuss the importance of returns on capital in a future post).
I highly recommend you check out Bruce Greenwald’s book on value investing, or one of his many videos on YouTube. The interview below (by Mercury Capital) is a good starting point.