Is Value Investing Unethical?

Followers of Benjamin Graham — such as Warren Buffett — often benefit from the cognitive biases of the average investor, and the systemic inefficiencies of the general market.

Benjamin Graham

Value Investing can, at times, be considered vaguely unethical. Warren Buffett's mentor — Benjamin Graham — wrote thus in his magnum opus:

"If the majority of investors, being in the defensive class, are not to buy them at all, the field of possible buyers becomes seriously restricted. Further- more, if aggressive investors are to buy them only at bargain levels, then these issues would be doomed to sell for less than their fair value, except to the extent that they were purchased unintelligently.

This may sound severe and even vaguely unethical. Yet in truth we are merely recognizing what has actually happened in this area for the greater part of the past 40 years."

Benjamin Graham, Chapter 7 - Portfolio Policy for the Enterprising Investor: The Positive Side, The Intelligent Investor.

Value Investors

First of all, Value Investors don't intend to benefit from cognitive biases and systemic flaws, but from the natural growth of the economy. They do this by investing and sharing in the profits of companies that are ignored — and often undervalued — more than they deserve to be.

Side-Effects

Now if — as a byproduct of this activity — they also benefit from the biases of those who tried to make a quick buck (and did not do their due diligence well enough), that's not unethical.

That's just being more industrious.

All Above Board

When the rules of the game are well-known and you're playing with the same deck of cards as everyone else — using techniques that you're telling everyone about and they choose to ignore you — that can hardly be called unethical.

Cognitive Biases

There may be an argument to be made that Value Investors are smarter, and are able to understand the theory of investing better than others in the market.

But if you're getting into things you don't fully understand with the intention of making a quick buck, and think you know better than experienced investors who're telling you not to do exactly what you're trying to do (buying overvalued businesses / selling undervalued ones), the results shouldn't be surprising.

Dunning–Kruger effect

The Dunning-Kruger effect is a cognitive bias in which those of lower competence lack the skills and cognitive abilities to recognize their own inability, and are more confident than the professionals.

Such illusory confidence can be a great ally in social interactions and even in job interviews, but investing is one of the few places it can prove lethal.

As Graham himself wrote:

"While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster."
Benjamin Graham, Introduction, The Intelligent Investor.
Advanced Graham Screener

Customized Value Investing

Systemic Inefficiencies

The systemic aspect of the argument can hardly even be considered a flaw. Businesses exist to make money, not to educate their customers. Most customers rarely even want to be educated.

Is Junk food bad for you? Yes.

Is a company more likely to fail trying to sell health food? Also, yes!

In the same way, brokerages are aware that day-trading does not work in the long-term. But they are also aware that if they don't cater to day-trading, most of their clients will simply move elsewhere. The most they can do is not encourage wrong behavior.

Graham again writes:

"In the past Wall Street has thrived mainly on speculation, and stock-market speculators as a class were almost certain to lose money. Hence it has been logically impossible for brokerage houses to operate on a thoroughly professional basis. To do that would have required them to direct their efforts toward reducing rather than increasing their business.

The farthest that certain brokerage houses have gone in that direction—and could have been expected to go—is to refrain from inducing or encouraging anyone to speculate."

Benjamin Graham, Chapter 10 - The Investor and His Advisers, The Intelligent Investor.

Conclusion

For the most part, Value Investors are unintentionally benefiting from flaws that everyone knows about; and they often tell everyone about. It's just that most people ignore them.

In fact, there is an argument to be made that Value Investing is actually a highly moral activity; since it redirects capital from over-hyped businesses to ones that are unfairly discriminated against, thereby helping bring balance to the market.

Graham Resources