Why Value Aversion Can Be Expensive
The question of value investing's lack of broad appeal has been visited by many over the years.
The typical investor or trader continues to search for some sort of Holy Grail that unlocks the secrets of instantaneous stock market wealth. Many people have searched for it over the years and very few have had much success in their quest. Select few have enjoyed some success, but most of those are real rocket scientists with advanced math and physics degrees backed by massive computing power.
With the exception of these gentlemen, most investors and even fund managers continue to underperform the broader market in spite of putting what seems to be a lot of energy and effort into the process.
The evidence in favor of value oriented approaches to investing is overwhelming yet for the most part is ignored by investors. It seems they would prefer to search for the next Apple (NASDAQ: AAPL) or Google (NASDAQ: GOOG) and balance their lunch while trading online on their lunch break. They must prefer searching chart books of miraculous chart patterns to make all their financial dreams come true over actually consistently making money in the markets. One cannot help but think these intrepid, busy but strangely unprofitable traders have missed out on a lot of good baseball games and books over the years hunched over cloud patterns and triangles.
It's not like all the research and investor success showing that value investing lacework is outdated.
The academic reviews of what does and does not work in the market are updated all the time. Some very interesting studies have been released in the past few years that continue to demonstrate a marked outperformance by patient deep value strategies. In spite of this, investors continue to chase quarterly earnings reports and stock stories.
A professor at the University of Rochester, Robert Novy Marx, has recently published a paper titled The Quality Dimension of Value Investing, that looks at several different approaches to deep value investing. His paper focuses on using gross operating profits along with price to book value and finds s a huge outperformance advantage over the broader market with fewer and smaller draw-downs. Although his proposed strategy works best, he also finds that the combination of book value and Piotroski F scores and other value based approaches also outperform the broader market.
Two professors from the University of Minnesota recently teamed with Tobias Carlise of Eyquem Investment Management to produce a paper titled Deep value Investing and Unexplained Returns. They found that consistently buying stocks that trade for less than 75 percent of net current assets consistently outperforms the market by a wide margin. In their own words, "We find that monthly returns amount to 2.55 percent, and excess returns using a simple market model amount to 1.66 percent. After controlling for a variety of risk factors and firm characteristics, and imposing several filters, we find a remaining significant excess return.”
This confirms the findings that were unveiled by Victor Wendell in his recent book The Net Current Asset Approach to Investing. He found that these cheap, unloved stocks had returned almost 20 percent annually when using what he calls his fully invested approach. If he could find enough stocks that met the criteria to have at least a 10 percent position he was fully invested in his research.
If not, the balance was in T-bills. The study looks at net current asset bargains from 1951 to 2009 and proves that this deep value approach worked better than just about any other approach to the markets not involving rocket science. Mr. Carlisle collaborated with a professor at Drexel University who also is the founder of the investment advisory firm Empiritage to write a book that should be on every investors bookshelf.
Quantitative value looks at several approaches to investing and finds that value strategies outperform glamour, growth and the market by a very wide margin over time.
One of the more interesting chapters in the book looks at Ben Graham's simple approach outlined in 1876 of buying stocks with low debt ratios trading at single digit PE ratios and find s that it beats the market by more than 50 percent from 1976 to 2011. The book also looks at several other measures for assessing value and finds them to be a market beating strategy.
It is not just the classroom research that proves the worth of a value approach to investing. The real world long records of investors like Walter Schloss, Michael Price and John Templeton have been pretty conclusive that patient value investing works better than any other approach an individual can use.
The reason they do not is a filed for the psychologists to examine but deep value investing is ignored at the cost of your net worth if you are an individual investor struggling to make money in the stock market.
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