Value investing comes in many stripes.March 31, 2016
First, there are the screeners, who we view as the direct descendants of the Ben Graham school of investing. They look for stocks that trade at low multiples of earnings, book value or revenues, and argue that these stocks can earn excess returns over long periods. It is not clear whether these excess returns are truly abnormal returns, rewards for having a long time horizon or just the appropriate rewards for risk that we have not adequately measured.
Second, there are contrarian value investors, who take positions in companies that have done badly in terms of stock prices and/or have acquired reputations as poorly managed or run companies. They are playing the expectations game, arguing that it is far easier for firms such as these to beat market expectations than firms that are viewed as successful firms.
Finally, there are activist investors who take positions in undervalued and/or badly managed companies and by virtue of their holdings are able to force changes in corporate policy or management that unlock this value.
What, if anything, ties all of these different strands of value investing together? In all of its forms, the common theme of value investing is that firms that are out of favor with the market, either because of their own performance or because the sector that they are in is in trouble, can be good investments.
Why does the efficient market leave a free lunch on the table in this era? The best answer is that the value phenomenon persists for the same reason it existed when Graham first conceived it: human beings behave irrationally. While investment tools have advanced, humans remain all too human, subject to the same cognitive biases that have plagued us since time immemorial. We may not be able to conquer these intrinsic behavioral weaknesses, but we can adapt our investment process to minimize them. The means to do so is: quantitative investment. Quantitative value has good investing DNA if we can trace its intellectual lineage back through Greenblatt to Buffett to Graham.
The key is to quantitatively define quality as financially strong stocks with franchises, evidenced by high returns on capital and high, stable, or growing margins through distillation.The primary rules essentially remain the same:
- Market should not drive one’s investment decisions.
- Invest decision should be driven by Intrinsic Value.
- Buy stocks as if you are buying a business.
However, big data is a catchphrase for a new way of conducting analysis. Big data principles are being adopted across many industries and in many varieties. However, adoption so far by investment managers has been limited. This may be creating a window Of opportunity in the industry.