Value investing is considered among one of the simplest and safest strategies for picking stocks that have potential for outperformance. Those who make a living outside the stock market in most cases simply do not have the time to spend analyzing stocks in the fullest manner, and so picking an easy to understand and easy to execute strategy is helpful in identifying stocks with a better chance for performing well.
Value investing focuses on picking a stock that is trading below its “intrinsic” value. This is the first part of a successful value investing strategy, to pick the right “value” stock. The second part focuses on maintaining discipline in trading when the stock reaches the anticipated “intrinsic” value, is sold and the expected return is realized.
In most cases, value investors focus on stocks based on indicators of value (current price below “intrinsic” value), such as low Price per share relative to Earnings per share (or P/E ratio); low Price/Book Value (P/B) ratio; or low Price/Cash Flow (P/CF) ratio. The most up-to-date readings of those ratios for most stocks are generally readily available online. Often, a stock that is trading at a P/E ratio below 10, or a P/B ratio below 1.0 or a P/CF ratio below 5 would be considered inexpensive, or at good value.
An alternative strategy to value investing is growth investing – where investors look for companies who have higher than average revenue and earnings growth and are projected to maintain this higher growth into the future. But we’ll leave this strategy for another day.
Returning to value investing, Benjamin Graham is considered the father of this investment strategy. He started teaching this investment approach at Columbia Business School in 1928. His famous disciple, Warren Buffet, called Benjamin Graham’s book, “The Intelligent Investor”, published in 1949, "the best book about investing ever written." Warren Buffet’s admiration of Benjamin Graham was so profound that he called his son, Howard Graham Buffett, after his teacher.
Benjamin Graham
Warren Buffet is probably the best known value investor of our time. Not only was Buffet Benjamin Graham's student at Columbia, but he later joined Graham’s investment firm. In 1965, Buffet took over Berkshire Hathaway and since that time, to last year (2015), Bershire Hathaway delivered a 20.8% annual compounded return – this compares to an annual compound return of 9.7% for the S&P 500 index over the same period. Warren Buffet’s net worth is currently estimated to be U.S $64.8 billion.
Warren Buffet
Another successful and well-known value investor was the economist John Maynard Keynes. Apart from being a revolutionary economist, he managed the endowment of King’s College at the University of Cambridge. According to the new research paper in Business History Review by David Chambers and Ali Kabiri (via Jason Zweig’s piece on http://blogs.wsj.com), in 1922-1946, Keynes’ stock portfolio outperformed the U.K. stock market by an average of 6.00% annually. This was a period marked by the worst market crash, the deepest economic depression and the most devastating world war in modern history. As the research paper notes, successful investing during this kind of period required a lot of preparation, courage and patience.
Because Keynes focused on stocks that traded at relatively low prices, he did not benefit from the bull market of the 1920s and, in 1924-1929, his portfolio had underperformed the British stock market by 40 percentage points.
But Keynes’ patience paid off as he did not waver in his value strategy. Keynes showed courage by investing in U.S. stocks after the 1929 market crash. Although stocks continued falling during the depression, he invested heavily in U.S. companies throughout the 1930s. The paper in Business History Review states that Keynes focused on a small number of stocks trading at low valuation ratios often holding these positions for periods of eight years or more until their prices rose to the anticipated “intrinsic” value. This is how he beat the broader stock market over the longer term.
John Maynard Keynes
Michael Zienchuk, MBA, CIM
Investment Advisor, Credential Securities
Inc.
Manager, Wealth Strategies Group
Ukrainian Credit Union
416-763-5575 x204
www.ukrainiancu.com
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