Value investing as strategy under scrutiny these days

Value investing as an investment philosophy was originally proposed and brought to prominence by Ben Graham is where one invests in stocks that are trading below their intrinsic value. In the later years, the Oracle of Omaha, Warren Buffet partnering with Charlie Munger made huge fortunes for themselves and their investors, thus becoming torch bearers of value investment strategy.

Value investors seek stocks which are mispriced or underpriced by the markets. So, when the market realizes the same, the price of these stocks eventually shoot up and the initial investors make huge long-term returns.

The key here is not to claim that one is following value investment but in identifying the intrinsic value rightly, and the other important factor is the time. Joel Greenblatt, another foremost expert on value investing and successful fund manager, achieving about 50 per cent annualized returns over a 10-year period with a remarkable consistency, where the lowest annual return during the entire period was about 28.5 per cent.

In his words, “the power of value investing flies in the face of anything taught in academics. Value is the way stocks are eventually priced. It requires the perspective of patience because the market will eventually gravitate toward value.”

Of late, value investing as a strategy has come under questions with a continued momentum in the stock markets across the globe. With racing stock prices, it becomes increasingly difficult to find the hidden jewel and the inflows only aggravate as on the increased allocation of cash (or demand) would drive the price away from their intrinsic price.

So, are there rules to follow or implement value investing strategy. Before, I jump into that I would want to talk about the distinction here required between rules and guidelines. For instance, we see rules to follow traffic. So, as per the rules we stop at a red signal and proceed at a green one. Likewise, we park at designated places for the vehicles only and any violations would be penalisd.
That’s true with any rule violations of traffic. Taking another example from our daily life, when we visit a physician for regular check-ups on blood pressure or diabetes, you would find an ideal range for each of the parameter besides your actual readings. These are not rules for maintaining good health but guidelines that could possible ensure good health.

In case of a person not following traffic rules, the penalty could be through violation charges or an accident which results in a loss and in some instances both. But, in case of a person following healthy levels of blood pressure or diabetes, it doesn’t actually stop them from having an illness but possibly allows them to lead a healthier life and also limits the complexity while treating any illness.

The answer for investing rules is a no, but yes do come with lots of guidelines. For example, mere cashflows of a company doesn’t reflect the true state of the company, despite having some great numbers there. Similarly, a company making huge profits wouldn’t make the cut of the investment.

This is because, it’s a range of parameters on how a company performs while the larger implications of the macroeconomic and geo-political considerations would decide for zero-in on a stock to be investment worthy. Add to this the sentiments of the overall investors to the stock market broadly and in specific to the sector in effect to the stock would also drive the decision of buying a stock.

Usually, it’s not these data points and their analysis that help the decision making but it’s like interpretation and contextualization of this analysis. When we look at the example of physician, he wouldn’t be gravely worried if just one parameter is off the mark but would check your other parameters, lifestyle, age, family history and more importantly his own experience.

The physician draws a lot from his own experience (partly imparted through education and partly through practice) to suggest you remedies. Ben Graham credited his success to breaking his own set of rules. This was reflected well as he constantly rejected the earlier ones while updating the newer ones in his later editions of his books.

So, how does one go about investing. Investing is hence only a part science despite the various analysis, charts, fundamentals, etc. and the other part being behavior, gut, sentiment, emotional, etc. Amazon is valued (market cap) higher than the rest of the all major traditional retailer together i.e. Walmart, Costco, Target, Macy’s and Kohl’s. Same is the case with Netflix which has near equal valuations when compared to Comcast which has seven times higher sales and forty times profits.

This is because stock prices don’t reflect the current situation of the company but the investor sentiment of the future. Now, did all the early investors of Amazon or Netflix follow value strategy?

BY K Naresh Kumar