Why Not Everyone Is A Value Investor
Value investing is a cornerstone of the Montgomery Global approach to allocating capital. In simple terms, value investing is trying to buy the proverbial dollar for fifty cents. In our eyes, buying stocks for less than they are worth is a sensible, time-tested way to making money in the stock market. But if this is the case, why doesn’t everyone adopt a value investing approach?
The truth is that value investing is challenging. Warren Buffett once said “value investing is simple, but not easy”. Charlie Munger also gave his thoughts on the matter with his usual curmudgeonly demeanour: “It’s not supposed to be easy. Anyone who finds it easy is stupid”. People have a proclivity to chase returns, and routinely allocate money to investment managers that have had a hot streak of good returns. That fear of missing out has arguably driven many into the Bitcoin mania – being bombarded by stories of people making silly amounts of money from Bitcoin created an allure, and potential gains, that were too great for many to resist (although the tide seems to be turning for Bitcoin!)
Rather than a get-rich-fast panacea, value investing requires discipline and astuteness to carry out an analysis to arrive at an intrinsic value for each investment. It can take months and sometimes years for the market to recognise value in a stock you believe to be undervalued. It also requires humility to acknowledge that your analysis may be wrong and to be intellectually flexible enough to change course when new information comes to light. It is these analytical and psychological prerequisites that make value investing challenging.
In addition to the difficulties in adroitly applying a value investing philosophy, value investing does not work well in all market conditions. If it did, everyone would subscribe to a value investing methodology, you would have more people scouring the world for bargains, those bargains would likely become scarcer, and then value investing would yield lower returns. This would most likely drive people toward other strategies of allocating money. There will be times when markets rally aggressively, leading to a paucity of value investing opportunities as stocks as a whole become more expensive. In times like these, we would expect a value investing strategy to relatively underperform.
So should one just switch between strategies? We believe no, and there are a number of reasons why: (i) if one devotes time to value investing, and then choses to switch to, say, momentum trading on the basis that market conditions are more amenable to this strategy, the skills learnt as a value investor are unlikely to transform into any meaningful advantage as a momentum trader; and (ii) there is no reliable way to time markets, and choosing a time to switch strategies is perilous (e.g., you might decide to change to a momentum strategy just as the momentum goes into reverse – a la Bitcoin).
Despite our preference for value investing, there are a multitude of ways to make money in the stock market. Take Stanley Druckenmiller or George Soros for example. Both of these macro traders have produced stellar returns for investors, with a strategy in stark contrast to the principles of value investing. There are certainly other ways to make money in the stock market, but the strategy chosen by an individual is a matter of personal preference. Whichever investment strategy is adopted, it has to resonate with that person’s goals and temperament.
Roger's step-by-step guide to valuing the best stocks and buying them for less than they're worth, Value.able, is available exclusively at rogermontgomery.com. Skaffold is an online stock-picking application that rates ASX-listed stocks from A1 to C5. Watch a demo of Skaffold at www.skaffold.com.