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Value Investing

What is Value Investing?
Value investing is an investment strategy that seeks to purchase relatively or absolutely undervalued stocks.

  • A stock that is relatively undervalued has lower valuation ratios (e.g., P/E, P/B, P/S, EV/EBITDA) than other stocks or the market in general.
  • A stock that is absolutely undervalued is trading below an investor’s estimated fair market value for the stock. The fair market value–or intrinsic value–can be calculated a variety of ways but is typically done so via a discounted cash flow analysis where the investor projects the company’s future cash flows and discounts them back to the present.

Types of Value Investing Approaches
There are many value investing approaches. Let’s look at three different value investors:

VALUE INVESTOR A VALUE INVESTOR B VALUE INVESTOR C
STRATEGY Purchases the cheapest top 25% EV/EBITDA stocks Buys only stocks trading below intrinsic value Looks for stocks below book value or sum-of-the-parts valuation
MARKET CAP FOCUS S&P 500 stocks All cap Less than $10 billion
NUMBER OF STOCKS IN PORTFOLIO 125 positions 30 to 80 but is dependent on number of opportunities Highly concentrated
TURNOVER Rebalances portfolio semi-annually Dependent on market conditions Typically holds positions for 1 to 3 years

Despite wildly different approaches, the above investors are all value investors.

Popular value investing approaches:

  • Deep Value: Looks for stocks trading below book value, net asset value, sum-of-the-parts valuation.
  • GARP: Growth at a reasonable price. Invests in growing, profitable companies trading at reasonable valuations.
  • Activist: Invests in undervalued stocks then pressures management to unlock value, sell company, or engage in other value creating initiatives.
  • Quantitative: Uses a systematic, mechanical approach to select stocks with a set rebalance frequency.

Does Value Investing Work?
Value investing has been thoroughly investigated by numerous academics and practitioners. The bottom line: value investing produces market-beating returns over the long run. Three important caveats:

  1. Value can go out of style and underperform the market for long periods of time.
  2. Value portfolios are typically more volatile than popular market indices.
  3. Some academics believe value stocks are riskier than non-value stocks and the excess returns historically generated by value stocks is simply compensation for the extra risk taken.

Below are a few notable value investing studies. We strongly suggest you review these studies yourself.

TITLE/BOOK AUTHORS METRIC/APPROACH TIME PERIOD RESULTS
Quantitative Value: A Practitioner’s Guide to
Automating Intelligent Investment and Eliminating Behavioral Errors
Wesley Gray and Tobias Carlisle Top EV/EBIT decile, rebalanced annually 1964 – 2011 14.55% per year vs. 9.52% for S&P 500
Quantitative Value: A Practitioner’s Guide to
Automating Intelligent Investment and Eliminating Behavioral Errors
Wesley Gray and Tobias Carlisle Top P/E decile, rebalanced annually 1964 – 2011 12.44% per year vs. 9.52% for S&P 500
What Works on Wall Street, Fourth Edition:
The Classic Guide to the Best-Performing Investment Strategies of All Time
James O’Shaughnessy Large cap top P/CF decile, rebalanced annually 1964 – 2009 13.56% per year vs. 10.20% for Large Cap universe
Investment Valuation: Tools and Techniques for Determining the Value of any Asset, University Edition Aswath Damodaran P/E ratio 1967 to 1988 Stocks in lowest (cheapest) P/E decile earned an average return of 16.26% vs 6.64% for the highest (most expensive) P/E decile.
Value Investing: Tools and Techniques for Intelligent Investment James Montier P/CF ratio 1950 to 2007 Cheapest 20% of stocks earned 20% p.a. vs. 11% for most expensive 20% (portfolios constructed using Ken French’s data)
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Value Investing

What is Value Investing?
Value investing is an investment strategy that seeks to purchase relatively or absolutely undervalued stocks.

  • A stock that is relatively undervalued has lower valuation ratios (e.g., P/E, P/B, P/S, EV/EBITDA) than other stocks or the market in general.
  • A stock that is absolutely undervalued is trading below an investor’s estimated fair market value for the stock. The fair market value–or intrinsic value–can be calculated a variety of ways but is typically done so via a discounted cash flow analysis where the investor projects the company’s future cash flows and discounts them back to the present.

Types of Value Investing Approaches
There are many value investing approaches. The most popular are:

  • Deep Value: Looks for stocks trading below book value, net asset value, sum-of-the-parts valuation.
  • GARP: Growth at a reasonable price. Invests in growing, profitable companies trading at reasonable valuations.
  • Activist: Invests in undervalued stocks then pressures management to unlock value, sell company, or engage in other value creating initiatives.
  • Quantitative: Uses a systematic, mechanical approach to select stocks with a set rebalance frequency.

Does Value Investing Work?
Value investing has been thoroughly investigated by numerous academics and practitioners. The bottom line: value investing produces market-beating returns over the long run. Three important caveats:

  1. Value can go out of style and underperform the market for long periods of time.
  2. Value portfolios are typically more volatile than popular market indices.
  3. Some academics believe value stocks are riskier than non-value stocks and the excess returns historically generated by value stocks is simply compensation for the extra risk taken.

Below are a few notable value investing studies. We strongly suggest you review these studies yourself.

Source: Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors
Authors: Wesley Gray and Tobias Carlisle
Metric/Approach: Top EV/EBIT decile, rebalanced annually
Time Period: 1964 – 2011
Result: 14.55% per year vs. 9.52% for S&P 500
Source: Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors
Authors: Wesley Gray and Tobias Carlisle
Metric/Approach: Top P/E decile, rebalanced annually
Time Period: 1964 – 2011
Result: 12.44% per year vs. 9.52% for S&P 500
Source: What Works on Wall Street, Fourth Edition: The Classic Guide to the Best-Performing Investment Strategies of All Time
Authors: James O’Shaughnessy
Metric/Approach: Large cap top P/CF decile, rebalanced annually
Time Period: 1964 – 2009
Result: 13.56% per year vs. 10.20% for Large Cap universe
Source: Investment Valuation: Tools and Techniques for Determining the Value of any Asset, University Edition
Authors: Aswath Damodaran
Metric/Approach: P/E ratio
Time Period: 1967 to 1988
Result: Stocks in lowest (cheapest) P/E decile earned an average return of 16.26% vs 6.64% for the highest (most expensive) P/E decile.
Source: Value Investing: Tools and Techniques for Intelligent Investment
Authors: James Montier
Metric/Approach: P/CF ratio
Time Period: 1950 to 2007
Result: Cheapest 20% of stocks earned 20% p.a. vs. 11% for most expensive 20% (portfolios constructed using Ken French’s data)

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