(FORTUNE Magazine) – FIVE YEARS AGO, in a Tudor-style house overlooking the Nebraska plains, Alan Parsow saw something that escaped Wall Street security analysts sitting a mere 50 feet from the headquarters of New York's Irving Bank: Irving's stock was a steal at $19 a share. Armed with his spreadsheet, Parsow figured that Irving was worth at least $75 a share. He bought 13,500 shares of the bank, which was named for Washington Irving. For five years his decision seemed wrong. The stock rose, but not nearly as much as the Dow Jones industrials. Convinced that Irving shares were still cheap even as they crept to $40, Parsow bought 12,000 more last spring. Then, on September 25, Irving shares suddenly awoke like Rip van Winkle. As Parsow foresaw, the stock shot from $52 to almost $80 a share in a single day when the Bank of New York offered to buy a controlling interest in Irving. Wall Street analysts were shocked. Says Parsow, now 37: ''The market finally recognized the true worth of the security. That's what value investing is all about.'' Value investing -- also known as the Graham and Dodd approach after its best-known articulators (see box) -- is a fuzzy concept, but its myriad variations share at least one clear aim: Find securities whose worth you can compute with confidence and that sell at significant discounts from those valuations. Many investors of the value school search for stocks selling below net worth -- the liquidation value of the company's assets minus total liabilities. Others look only for stocks selling for less than a company's net working capital -- current assets minus current liabilities. But few value investors are slaves to a formula that tells them when to buy. Value, like beauty, is in the eye of the beholder. IN THE YEARS since World War II, the value investing school has produced some of the world's most successful money managers. Many studied at Columbia University under the late Benjamin Graham, the founder of modern security analysis. All have read Graham's two most important works on investing -- Security Analysis and The Intelligent Investor. Today's greatest investor almost certainly is Warren Buffett, chairman of Berkshire Hathaway, a conglomerate that has been his principal investment vehicle since 1970. Buffett was Graham's star pupil. He received an A+ in Graham's class at Columbia and went on to earn even higher marks in the real world. From 1957 through 1969 Buffett ran an investment partnership that earned a remarkable 23.8% a year -- after his management fee. The book value per share of Berkshire Hathaway rose at a rate of 24.5% per year from 1970 through June of this year. Friends of Buffett who also studied with Graham, including money managers William Ruane of Ruane Cunniff & Co. and Walter Schloss of Walter J. Schloss Associates, have done almost as well. While most investors are pushed and pulled by their emotions, value players try to stay detached from the follies of the marketplace. They focus on what a company is worth today, not what it might be worth tomorrow if earnings meet Wall Street's expectations. When buying, they never chase a stock that goes up in price. And if the intrinsic value is still there, they don't dump a stock just because its price has dropped. Patience and reason are their bywords. Says Buffett: ''Investing isn't like baseball. They don't call balls and strikes, so you don't have to swing at every pitch.'' After five years of ascending stock prices, it is obviously difficult for the disciples of Ben Graham to find companies they consider cheap. Many value investors have lagged behind the market averages this year, in part because they refuse to buy the average stock. They would rather put as much as 50% of their capital in Treasury bills. Some pundits have declared that if value is so hard to find in the market, then value investing has lost its usefulness. That seems unlikely. Value, after all, is what the stock market is supposed to be about. And value investors are still finding a few stocks -- and bonds -- that meet their standards. Four of the best told FORTUNE how they zero in on underpriced securities and then identify the ones they feel most comfortable buying. Each offers insights into how the amateur can invest with a margin of safety in today's heady market.

LOOKING FOR WELL-RUN COMPANIES Born in Omaha, Warren Buffett's home town, Alan Parsow was raised to be a value investor. His father ran Parsow's Fashions for Men, where Buffett shopped. Parsow approached Buffett in 1972 ''to apprentice myself to Warren, just to see if I could learn the business.'' Buffett turned him down, suggesting instead that young Parsow read Graham's books and strike out on his own. Parsow devoured the books and set up a tiny, $27,500 investment partnership, using the same bookkeeper and lawyer who helped Buffett get started. Parsow promptly lost two-thirds of his original capital in the bear market of 1973. The experience brought home the importance of two of Buffett's rules of investing: ''The first rule is not to lose. The second rule is not to forget the first rule.'' Investors in Parsow's partnership have done much better since then. From 1975 through September 1987, they received an average 21% annual return. Standard & Poor's 500-stock index rose 18% a year in the same period. A hefty chunk of the partnership's estimated $40 million in capital belongs to Parsow. Like Buffett, Parsow invests only in companies whose managers he respects. Parsow, however, sometimes buys technology stocks, a group that Buffett disdains. Orbit Instrument Corp., a defense electronics company in Hauppauge, New York, is an example. Says Parsow: ''I really admire the chairman, Max Reissman. He's a manufacturing genius and a fanatic. He's at the office at 6 A.M. and leaves at 8 P.M.'' Orbit's gross profit margin of about 30% is among the highest in the industry. And the company is nearly debt-free. The stock recently sank from $9 per share to the $7 Parsow originally paid for it because Orbit lost 15 cents a share in the latest quarter. But Parsow says Orbit is now making money at an annual rate of 70 cents a share.

The founder of Republic National Bank of New York earns high compliments from Parsow: ''Edmond Safra runs Republic the way Warren Buffett runs Berkshire Hathaway -- on a low-risk, low-cost basis.'' Other banks envy Republic's 14% return on equity, especially given its unusually conservative lending policies. The bank's gold bullion trading operation profits handsomely whether gold prices move up or down. Republic, which should earn $6 per share in 1988, traded recently at $53 a share, about 50% more than book value. Safra has announced his intention to buy one million shares for his own account. For those wondering if Parsow owns any Berkshire Hathaway stock, he does. It is 1% of his portfolio. ''I am an idiot for not owning more,'' he says.

A STRICT GRAHAMITE While Parsow is rooted to Nebraska, Peter Cundill, president of Cundill Value Fund, travels the world in his quest for bargains. The 45-year-old Canadian works out of plush digs in London when he isn't in Hong Kong, New York, Paris, or Vancouver. Cundill's $218-million fund is up a respectable 28% for the first nine months of 1987. From 1975 through 1986, he achieved an annual rate of return of almost 24%, vs. 16.4% for the S&P 500 (including reinvested dividends). The fund has never lost money in a calendar year. A chartered accountant, Cundill is among the purest of Grahamites. He discovered value investing in 1973 when he read a chapter on Graham in Adam Smith's Supermoney. Recalls Cundill: ''I said to myself, 'That's exactly what I want to do.' '' He seeks out the stocks of profitable companies selling at less than their liquidation value. When the shares are at half book value or less, he buys. After they double or reach book value, he usually sells. Cundill owns the stocks and bonds of companies trading on exchanges in a dozen countries, including Canada, the U.S., Mexico, Britain, Denmark, Singapore, Hong Kong, Australia, and New Zealand. ''To a Canadian, almost all the stocks in the world are by definition foreign,'' he says. ''And given the dearth of bargains today, it pays to search for them everywhere.'' Cundill hesitates to tout a stock he owns because he may buy more and doesn't want to drive up the price. But Cundill has to report the fund's portfolio to shareholders, and the most recent statement reveals some stocks that are at or below his purchase price. One is British Columbia Resources Investment Corp., a Canadian coal and saw-mill company recently selling at 75 cents a share. Cundill estimates the company's breakup value at $1.50 a share or more, and says it may earn 30 cents this year on its sawmill operation alone. He bought his shares at $1.31. He also owns shares of MCorp, a troubled Texas bank. Cundill bought at about $7.50 a share, and the stock recently was down to $6, one-third of book value. He says the current price is about equal to the value of MCorp's data-processing subsidiary plus cash on hand -- meaning that investors can effectively get the bank itself for free.

BUYING BANKRUPT COMPANIES Jack Kneafsey, a 40-year-old broker in Prudential-Bache's Baltimore office, specializes in the securities of bankrupt and near-bankrupt companies. He is as good as they come at selecting stocks and bonds that will be worth a great deal more after a company emerges from Chapter 11. Most investors heed the old Wall Street axiom ''Never buy into a lawsuit,'' and avoid faltering companies. But ever since he won big on the bonds of the then-bankrupt Penn Central in the 1970s, Kneafsey has ignored that warning. Over the past eight years, says Kneafsey, three clients who invested in almost all his bankruptcy and reorganization recommendations have seen their accounts soar in value over 1,000%. Kneafsey argues that his strategy entails very little risk. That is because he does not invest in just any old bankruptcy. As odd as it may sound, he picks what he calls ''undervalued bankruptcies.'' Those are companies whose assets are worth more than their liabilities, and several times what their stocks are selling for. ''That is value,'' says Kneafsey. Finding riches in the financial world's junkyard keeps Kneafsey up late crunching numbers for his detailed spreadsheet analyses. He watches sick and dying companies long before they expire. ''I keep them in sight for six months to a year before moving in,'' he says. Kneafsey is especially attracted to the common stock of Storage Technology, once a highflying data-retrieval company. It went bankrupt in 1984 and emerged from Chapter 11 this past July. Kneafsey says that new management has the company earning at the rate of 25 cents a share in 1988, and Storage Technology has a $180-million tax-loss carry-forward to shelter profits. Says Kneafsey: ''The common, at $2.875 a share, could be a dramatic success over the next few years.'' He figures it could rise to $6. Another ailing duck that Kneafsey keeps an eye on is LTV, which went into Chapter 11 last year. He thinks that LTV bonds will reward the informed investor, but not just yet. The reorganization may take a while because the federal government is insisting that LTV assume its pension fund's $2-billion unfunded liability.

MEASURING THE PROBABILITIES The man who may be advancing the art of value investing the most is Seth Klarman, 30. He is one of two general partners of the Baupost Group's four equity partnerships. Klarman helps manage more than $100 million from a messy office near Harvard Square in Cambridge, Massachusetts. He has been buying and selling stocks since he was 10. Says one Wall Streeter who knows him well: ''Klarman is going to be a Buffett-class character.'' Baupost's performance supports that assessment. Even with 25% of their assets in cash, the four partnerships had annualized returns from February 1983 through August 1987 that ranged from 23.5% to 33%. The total return (capital gains plus dividends) on the S&P 500 was 24.3% a year over the period. Klarman prefers an eclectic approach to value investing, as opposed to simply buying stocks that are selling below a company's breakup value or for less than its net working capital. ''It's easier to follow a formula than to analyze each security,'' he says. ''But we prefer to give our brains frequent exercise.'' His thinking is innovative. Klarman invests roughly 10% of a partnership's capital in a diversified portfolio of securities he feels have value only in the probabilistic sense. That is, he may buy a $1 stock that he believes has a 50% chance of rising to $5 and a 50% chance of falling to zero. Over the past three years he bought 3.5 million shares of Telefonos de Mexico, the Mexican national telephone company, at an average cost of 10 cents. That is 20% of book value and less than the company's annual cash flow per share. Says Klarman: ''We acknowledged that we could not fully evaluate all the risks in Mexico, but we also saw the chance for a big gain and rather less risk of losing our investment.'' He sold recently at 50 cents a share. The Baupost portfolio contains three less risky types of securities: companies in liquidation, ones that are restructuring, and plain old underpriced businesses. One liquidation play Klarman likes is City Investing Liquidating Trust, the publicly traded security that has a call on the remaining assets of the City Investing conglomerate. The trust has 80 cents a share of cash, and Klarman believes that investors stand to receive $1 or more in the next six months from the announced sale of a heating and air conditioning manufacturer. It traded recently for $4.50 a share, and Klarman believes the total package is worth at least $5.50. Klarman recently bought high-yield bonds of bankrupt Texaco. ''Texaco is as solvent as anything for the senior bond holders, even if Pennzoil gets $10 billion,'' he says. He prefers Texaco's higher-coupon securities that mature before 1992. For more orthodox value investing, Klarman favors savings banks. He believes security analysts cannot cover the thrifts well because so many have recently converted from mutuals (owned by their depositors) to stock companies. Well- managed, profitable savings banks sell in the stock market at half what acquirers are paying for comparable ones in private transactions. Says Klarman: ''That's not a made-up value. Every month there's a deal for a small thrift at 1.25 to 1.5 times book value.'' His favorites are Heritage Northampton Institution for Savings in Massachusetts, Peoples Savings Bank in Monroe, Michigan, and United Savings & Loan of Greenwood, South Carolina. All four of these value investors believe the torrid stock market of the past five years is about to cool. A self-described worrywart, Klarman writes an annual letter to investors in his partnerships that is almost as useful a guide to investing as Warren Buffett's fabled epistles to shareholders of Berkshire Hathaway. In Klarman's latest message, he quotes a passage from comedian Woody Allen that Buffett has also invoked. It expresses many a value investor's view of the market: ''We are at a crossroad. One path leads to despair and utter hopelessness, the other to total extinction. I pray we have the wisdom to choose wisely.''