David Dodd - Value Investing

Value Investing

The phrases "Graham and Dodd," "value investing," "margin of safety," and "intrinsic value" — all biblical to value investors — are often used interchangeably when referring to an approach to investing. Despite the onset of modern portfolio theory (MPT) in the late 1950s — a theory that peaked throughout the 80s, gaining Nobel recognition in 1990 (co-laureates: Harry Markowitz, Merton Miller, William F. Sharpe) — Value Investing proved to be a formidable style that sharply defied MPT. The University of Chicago was at the center of MPT (see "quantitative analyst") while Columbia has been the Mecca for Value Investing for 7½ decades. Many cracks in MPT are now well established, whereas the basics behind Graham & Dodd’s approach to Value Investing are as valid today as when they were first introduced.

Value Investors see securities as either priced correctly, under-priced, or over-priced. In contrast, MPT proponents insist that, by definition under the efficient market hypothesis, a realized price of a stock is the correct price. Value investor purists reject the usefulness of Capital Asset Pricing Model (CAPM), in part, because it wrongly extrapolates historical volatility as a proxy for risk. For example, if equity prices of a company fell 75%, assuming the underlying fundamentals of the company were solid, an MPT practitioner would view it as volatile (risky); whereas, a value investor would determine whether it was undervalued, and, if so, buy it reasoning, among other things, that the resulting downward risk is less than before. Therefore, value investors see MPT metrics — such as standard deviation, beta (relative standard deviation), alpha (excess return), and the Sharpe ratio (risk adjusted return) — as inadequate and even misleading.

Columbia resisted de-emphasizing Value Investing during the throes of the MPT renaissance, but the appeal of MPT seemed to be part of a larger movement, thrusting finance aspects of business education into higher echelons of academia. During about a 25-year period (1965–90), published research and articles in leading journals of the value ilk were few. Warren Buffett once commented, "You couldn't advance in a finance department in this country unless you taught that the world was flat." Shortly after the death of David Dodd in 1988, Bruce Greenwald, a star professor at CBS, took a keen interest in Value Investing. He found the overwhelming success of Value investors difficult to dismiss. At the same time, reliable data that fortified Value Investing was solidifying, while MPT was showing some flaws. Professor Greenwald invigorated the academic aspects of what many in ivory towers erstwhile treated as a vocational discipline.

MPT pundits argue that the Warren Buffett's long-term record is a statistical three- to five-sigma event — that is, his success is probable, but not replicable with certainty.

Yet the success of numerous other investment funds and practitioners who applied value investing theories weakened assertions attributing success to chance. Because Value Investing rejects MPT and its use of sophisticated statistics, there's irony when MPT theorists attribute its success to tails of standard deviation. Bruce Greenwald overhauled and relaunched the Value Investing curriculum at Columbia in the spring of 1994. Today, Value Investing enjoys broad appeal among academicians and investors around the world. Professor Greenwald is the Robert Heilbrunn Professor of Finance and Asset Management at Columbia University's Graduate School of Business. David Dodd died September 18, 1988, aged 93, of respiratory failure at Maine Medical Center, Portland, Maine. At the time of his death, various editions of the book he coauthored, Security Analysis, had sold over 250,000 copies. His daughter, Barbara Dodd Anderson (1932–2010) lived in Northern California and was a benefactor of the Heilbrunn Center for Graham and Dodd Investing.