Jesus is the way!

With that, I’m going to round out my foundational investment series with what may be the least favored among investors today. Value investing historically has been a winning formula but that hasn’t been true in the age of easy money.

Let’s uncover some of the most important concepts as they relate to value investing with hope we can identify if this sleeping giant will ever wake again.

Of course, I’m not an investment professional and this isn’t a recommendation to ever invest. Always conduct your own due diligence or be sure to speak with someone who has.

Post Contents

What is Value Investing?

Value investing is foundationally about finding companies or assets that are currently undervalued. However, no one person or group seems to agree on what constitutes a value. For some, Microsoft at $400 is a value, to others value won’t be seen until $300, and so on.

Valuation of an asset heavily manipulated by emotion and other market forces is no easy task. However, the belief among value investors is that over time the share price will follow the fundamental dynamics of the business. Historically this has been true, with the S&P 500 climbing higher over time.

Overall, value investors intend to identify segments of the market currently out of favor or out of alignment with their fundamental data. Invest while price is low and profit from the inevitable rise in price before wall street or main street gets in.

Personally, I’ve elected to focus on value investments in the form of ETF’s. You may be interested to view my holdings current performance in real time by visiting my portfolio page.

Defining Characteristics

There are several traits to a valuation candidate that investors would do well to identify. As a sidenote, for those investors with an affinity towards value investing it isn’t uncommon they find treasure where everyone else sees trash. By uncovering data others haven’t yet identified prior to a trend value investors could see outsized returns.

Regardless, these characteristics are a much needed starting point for any value seeking investor.

  • Disparity between financial data and share price
  • Forward leaning business model
  • Products or services on the horizon
  • Extraordinary management
  • Consistent cash flow

Truly, not an exhaustive list but rather an introduction to the types of information a value investor might seek to identify. The most astute or determined of this investing class will undoubtedly return a host of criteria average investors may never think to consider.

Still, this approach might prove to be more risk than reward. For example, uncover an extraordinary management team but later find they offer an inferior product or service would more than likely result in further price declines.

Is Value Investing Dead?

No one truly knows that answer but it would seem in today’s market growth assets or income generators do receive the most attention. That said, valuing stocks is anything but dead as countless market participants take to social media with their value proposition for one stock or another.

In an effort to find an answer to this question, here is an article from Cabotwealth.com providing some appropriate context for the state of value investing. Certainly not dead, just evolving. For example, value investors may find it difficult to prove the worth of a new technological advancement. Will artificial intelligence revolutionize the world or is it a neat parlor trick? As of today, it appears the former but to what extent would a value investor be able to identify or capitalize on that knowledge? That is what value investors are intending to find.

While we can say certainly value investing isn’t dead. Finding that value has never been more difficult. Meaning, true value focused investors have likely adopted a hybrid approach wherein they seek to find value within a particular growth prospect.

Quality over Quantity

A lesson I learned far too late in life is that more is not better. Traditionally, it was common for a value stock to boast a below average share price. Only helping to identify good companies experiencing a temporary slump. Today, value may still be found in those assets currently at or above a fair market value.

A quality asset is a quality asset no matter what investing label is applied. It is more than possible to find value in a growth stock or growth in a value stock. A through understanding of this fact would assist a potential investor from avoiding an opportunity simply because it didn’t fit neatly into a predefined category.

Sustainable high quality value investments generally possess, among other attributes; strong financial metrics, a competitive product or service, a capable management team and even an attractive share price. Market participants would be well served to also identify those value candidates having existed through numerous market cycles.

Ironclad Fundamentals

Before we look at some of the financial characteristics inherent to a traditional value investment it’s important to note that this list isn’t intended to be exhaustive and it may be proved shortsighted in today’s market environment. Still, the criteria outlined here will more than assist a potential investor on their quest to finding an underperformer.

I’ll start with a focus on those criteria that improve shareholder yield. Items that return value to the shareholder would be share buyback programs, dividends, or debt reduction initiatives. An investable asset prioritizing these traits would be first on my list of possible investments. Neglecting these items wouldn’t necessarily eliminate the opportunity but would seriously undermine the investment, in my opinion.

Next, an identification of those assets currently below their net asset value may also prove useful. Net asset value is determined by subtracting total liabilities from current assets. Additionally, a low price to sales ratio could indicate an under valuation, especially if it were true in comparison to comparable peers.

Finally, I’d seek to identify those investments boasting terrific free cash flow growth, an improving debt to equity profile, and the defensive characteristics of such an asset.

Again, please take notice that this is indeed an unqualified approach to value investing. These metrics and many others would likely be required to develop a complete investment thesis. Though, identify an asset fitting these criteria and the foundation for an investment would be compelling.

Against the Crowd

Possibly a hallmark characteristic to any great value investor is their ability to invest where few others would. To invest in this space when everyone else is running the other way would take a level of fortitude and insight that I myself do not have.

Though, in an ever changing market environment this approach carries a well above average level of risk. Investing in and of itself means accepting the risk of loss but to assume that risk when an asset could be outright failing would I believe be known as, “catching a falling knife”.

To those few investors preferring to move against the crowd, I offer you an even greater word of caution. Contrarian investing is far from the easiest path and one I know I’m myself could not follow.

Performance Characteristics

Since the financial crisis of 2008 true value investors have become more and more rare as growth or income investors abound. In fact, the underperformance value investors have endured is even more concerning considering this article from Alphaarchitect.com. Admittedly, the article is quite dated as of today so more research would need to be conducted to better understand the value to value investing.

The primary performance hindrance to value investing rests solely, in my opinion, on the technology sector. From 2008 when the first iphone was introduced our world has seen broad technological advancements with even more on the horizon. As I write this today, electric vehicles are the norm and flying electric taxis are already shuttling people around. Artificial intelligence is becoming real intelligence and investors are lining up to invest. There are sure to be hiccups on this wave of technological advancement but they may be too few and far between to benefit the old school value investor.

However, there is light at the end of this considerably dark tunnel. When covid-19 shut the world down, value investors again had a brief moment of victory. With growth stocks falling precipitously investors were flashed backward in time to that period when investors must conduct due diligence to realize a market gain. In today’s market, to earn a sometimes outsized return means simply buying into the latest trend.

That said, it’s imperative that value investors remember that nothing lasts forever. When cutting edge technologies begin to wain or public opinion ultimately sours then value investing may once again have its day. Until then, tread cautiously and carefully ahead.

Downsides to Value Investing

Possibly the greatest downside of any investment technique in existence would be the classic value trap. Essentially a value trap is a formerly good business that is slowly getting worse over time. These assets may still boast a respectable financial profile but that profile is weakening, even if it isn’t plainly visible.

As I write this today, an asset or really an entire asset class that fits this criteria is the financial technology sector. Paypal and SoFi come to my mind. In fact, a simple reddit search will return an ongoing debate about the merits of either company. Will they turn around in the future, I’m not sure, they may indeed be a classic value play but that would be where the true value investor digs in to find out.

Pulling at that thread, it should also be stated that not all cheap stocks would be value investing opportunities. Some indeed may go on to outperformance but most will be relegated to the pages of history. Making the value proposition to value investing even more of a question mark.

Finding a value candidate worthy of consideration also requires an outsized amount of work researching and studying endlessly with hope to find some detail everyone else has missed. This could only be viewed as a downside when it would be just as easy to pile our investment capital into the likes of Nvidia and earn a return with currently no downside in sight. As I write this today, Nvidia has indeed entered the stratosphere and their performance has largely carried the indexes to continual all time highs.

Ultimately, the list of downsides to a potential value investor is a long one. Entering this space without a carefully, and I do mean carefully crafted plan would be ill advised. Though, as I’ve mentioned, nothing lasts forever and value investing is sure to one day return to relevance.

Value Traps

Briefly mentioned above, value traps are deserving of an entire subsection. Thus, the importance of avoiding this age old mistake couldn’t be overstated. In my experience, the bulk of the stock market should probably be quantified as a value trap. In a time of ultra connectivity and marketing masterminds companies will stop at nothing to convince investors or consumers of their superiority. An ability to avoid this potential distraction would likely mean your a robot or very highly trained.

Value traps are so difficult to avoid because they play on the classic value proposition. Often having financial criteria or other characteristics similar to that of a good business currently experiencing a tough period. Ask anyone in the investing community and they’ll tell you of Apple or AT&T in the 80’s or 90’s and those stories inspire us all to invest. Still, most companies are not Apple or AT&T so investing limited capital into any asset that the investor couldn’t prove without any doubt would more closely align with gambling.

Lastly, and again this couldn’t be overstated. Accounting professionals have an uncanny ability to make lemonade out of a business’s lemons. While the SEC is always investigating fraudulent activity they will never catch every company fudging the numbers. Our hope as investors is that this practice remain only in the movies but however unfortunate. It happens and probably more than any of us will ever know.

Value Investing Tools

With the value investing landscape more challenging than ever before I felt it important to include a few tools that may make a value investors job a little easier. These are all tools I myself have used so I trust they provide accurate and valuable information. However, I’m limited to my own experiences so anyone considering this investment approach would do well to continually seek out those tools that may offer an edge for the future.

Final Thoughts

With a relatively full view of value investing now behind us it will be imperative that the aspiring value investors of tomorrow not repeat the mistakes of the past. While there may be a laundry list of reasons to avoid this style of investing, those willing to do the work will earn the rewards. That, I’m convinced, will always be true, no matter to what facet of life it relates.

The very nature of value investing is compelling to our logical brain. We are hard coded by God to seek out the value proposition in every area of our lives. This is even more true as we seek to find valuation discrepancies within the market.

But I hope you’ll remember this, the road may be rigged to explode and the morally corrupt among us are only interested in their own gain. No doubt telling you at every step what you should be doing or why your just plain wrong. Still, to the value investor born for it, every distraction will serve only as proof they’re doing exactly what they were made for.

Until next time.

God bless,

Jeff

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