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Value Investing is Back in Vogue. With the markets state of turbulence, investors are scurrying to find those hidden gems that are not only trading at bargain prices, but which also have some hope of surviving - relatively intact - from the ups and downs of market volatility. Thats why an increasing number are tapping into that old standby that can be counted on through thick and thin: value investing.

Value investing is simply investing in companies whose shares are temporarily trading at lower prices than their true worth.

In 1934, Benjamin Graham, with his colleague David Dodd, co-authored Security Analysis, the primer for value investing. Many editions later, the book has become the bible of security analysts nationwide.

Graham felt that too many investors were speculators - buying or selling simply because a stock or the market went up or down, investing in hot stocks, and margin buying - all trends of the era in which he grew up. He lived through the debacle of the 1929 crash, the bank closings and the utter loss of confidence in Wall Street. He knew for confidence to be restored, and for corporate America to obtain the funding needed for expansion, individual investors would have to be brought back into the fold.

Graham proposed that the foundation of sound investing should not change with the whims of trends or the winds of time, but should be altered only as a result of important economic and financial changes. Such events might include changes in interest rates, inflation, the trend toward mega-corporations, or significant bankruptcies - all occurrences which might alter the way a stock is to be valued - quite a different train of thought than what was currently espoused by the professionals. You might imagine how popular that advice was with the Wall Street crowd!

The father of value investing felt that a good investment should be a company that was worth considerably more that what its stock was selling for. He calculated this value of a company by estimating its future earnings as well as taking into account the worth of its assets - what would be the value of this business to someone interested in buying it. And although even during Grahams day, there were always analysts ready to build a mountain out of a molehill, cranking out scores of ratios to analyze one company, Graham felt that just a few - the most important - criteria would do the job.

Graham especially liked to invest in companies whose earnings were reasonably stable, with good growth prospects. Additionally, he required that they be conservatively financed, large companies that paid dividends, and had price-earnings ratios of less than 25. And he found legions of such companies - many that were selling for less than their net working capital (current assets - current liabilities). But for some reason, the stock market and the market pros were underestimating, or undervaluing the potential of the companies' earnings, resulting in an undervalued stock price.

Grahams success was legendary. During his most active years - from 1936-1956 - he consistently posted annual returns of 20% plus, while the S&P 500s performance ran around 14%.

And his legend lives on. One of his most diligent students at Columbia University was Warren Buffett, who followed Grahams teachings and became even more famous than his professor.

While Benjamin Graham introduced value investing to the investment community, Warren Buffett actually formed a company whose sole purpose is to value invest. He is chairman of Berkshire-Hathaway (NYSE: BRK-A) - a holding company that is essentially a portfolio of the stocks of businesses he has bought over the past 50+ years. And along the way, he has expanded on Grahams version of value investing.

Like Graham, Buffett seeks those companies that are undervalued in terms of todays numbers. He certainly looks at future earnings but doesnt rely on them to make a buying decision. He expresses this concept by saying, Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. His secret to Wall Street riches is simple: You try to be greedy when others are fearful and you try to be very fearful when others are greedy. Alternatively stated: Dont follow the crowd.

Buffett believes that research is the key - nothing beats old-fashioned elbow grease. He disregards hot tips, sets his goals and targets for the company at the time he buys the stock and believes that too much diversification - what he calls the Noah School of Investing, or buying two of everything - is not prudent. In fact, Buffett tends to take rather large positions in the companies that he owns in his Berkshire-Hathaway group, and keeps his portfolio fairly lean, in terms of numbers of companies.

That focus on a smaller group of investments led to one additional criterion that Buffett added to Grahams model and ultimately made his trademark - he believes in really getting to know the companies in which he invests. That means personal visits and conducting ongoing communication with the decision-makers. But Buffett takes that step even further. He also gets to know the company's customers, suppliers, and its competitors.

Another expansion of Grahams strategy is Buffetts addition of qualitative factors to the investment equation. While Graham certainly considered whether or not management was strong, efficient, and cost-conscious and that the company's products seemed worthwhile, Buffett also looks at more intangible qualities, such as franchise or brand name value. For example, before he bought Disney stock for the first time, he factored in the value of Disneys huge movie library, which did not show up on Disneys financial statements at that time.

This led to Buffett changing Grahams concept of the worth of a business by adding such intangibles to a companys book value, which is basically defined as a companys assets minus its liabilities, or the capital that has gone into a business, plus retained profits. Together, the actual balance sheet figures plus the intangibles, add up to the intrinsic value of the company.

And lastly, Buffett enlarged Grahams definition of risk to include the risk of paying more than a business would prove to be worth.

Buffett has often been maligned in the media for his conservative investing practices. He has always avoided what he calls fashion investing, or buying into go-go stocks. And he has stated more than once that investors should only buy stocks within their circle of competence, meaning if you cant explain it to your 90-year old grandmother, you shouldnt spend your hard-earned money on it. His portfolio has always consisted of household-name companies, including Coca-Cola, American Express, Disney, the Washington Post and GEICO.

In the late 1960s, he was attacked for staying out of the hot electronics sector and retaining his old-line retail stocks. But he had the last laugh there, just as he had during the recent technology boom. At the turn of the millennium, Buffett was crucified in the media and called a has-been for admitting that the business of most of the hi-tech stocks was over his head and he was sticking to his knitting. As time would tell, he was right again.

And Buffett has the juice to back up his strategy. For the last 200 plus years, the stock market has averaged 11% annual gains, while Buffetts average annual return since 1951 is around 31%. And he inspired countless other value investors, including Peter Lynch.

Click the Value Investing header link above to learn how to invest like Warren Buffett.

Good day and good value investing.

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