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Value Investing Is Another Pillar of Investment Success

Value investing is an approach to investing with a longer history than that of indexing.  Although it has existed for hundreds of years (its essence is to be contrarian and buy bargains), the 20th century use of this technique was popularized by Professor Benjamin Graham who taught at Columbia University.  Ben Graham was the author, in 1959, of the Intelligent Investor, which popularized long-term value investing as the soundest foundation to long-term investment success.

Ben Graham's most famous pupil is Warren Buffett, now the second wealthiest man in the world, who created his fortune largely based on the principles of value investing.  Despite its pedigree and track record of success, many investors have not incorporated an emphasis on value investing in their own portfolios and/or are unable to maintain this discipline on a consistent basis.

Although there are multiple schools of value investing, each with their own implementations of the same basic ideas, all value investors share certain principles.  First, value investors believe that prices matter, i.e. the lower the price of an asset at the time of the investment, the greater the safety and potential returns associated with that investment over the long-term.  As a result of this price matters philosophy, most value investors tend to look for investment opportunities among unpopular and out of favor areas.  Value investors pay attention to current metrics of cheapness, including financial ratios like price to earnings, price to sales, and price to book value.  When companies are out of favor, their prices fall as other investors sell, so that these ratios for value companies are often lower than those of the general market.

Most importantly, both qualitative and quantitative studies (including academic studies) support the notion that adopting a value oriented approach to investing can result in higher returns (academics argue that this return may come at the price of higher risk/volatility of value stocks - a notion that others find debatable).  Whatever the reason, value investing seems to work well for those investors who take a long-term approach.  Enhanced indexing (properly utilized) can draw on the strengths of both indexing and value investing to offer intelligent investors some powerful tools to manage their portfolios for long-term compounding.  

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