Low Price to Something investing, or “value” investing as it has come to be known since Fama/French introduced the “value” factor has been a disaster for investors over the past 10 plus years.
Academics and quantitative managers continue to argue that the time for cheap stocks will return, because it always does. While hope is comforting, it is not a wealth creation strategy. Indeed, “value” stocks may become so neglected by the market that they become a compelling purchase again, but at what cost to client portfolios in the meantime? The siren song of “the time for cheapness stocks is now” is very alluring, causing principled portfolio managers to secure fame and fortune as asset allocators rather than stock pickers. Unfortunately, cheapness approaches bank on correlation rather than causality, which in portfolio construction as most things in life leads to unexpected ruin quite often. For the investment management industry, so long as the focus on “value” is determined by cheapness indicators, client portfolios will suffer from not receiving the full long-term benefit of buying stocks at a discount to their intrinsic value.
Cheapness investing suffers from a confusing correlation with causality much like the practice of leeching in the 18th century. Did leeches improve patient health, or did patients benefit from some other unknown factors? Perhaps, patients benefited from the rest involved in completing a leeching cycle? Maybe it was the medical equivalent of an extraordinary hot streak? We don’t know. But over time with better theory, research, and empirical study we did resolve that leeching is not best practice. The same applies to cheapness investing.
Cheapness investing has through brilliant marketing, co-opted the definition of Value Investing, which is unfortunate. A painting from Monet or a first grader is still a painting. The definition of painting has not been perverted. However, allowing value investing to be defined by the use of cheapness variables is a brilliant marketing deception.
As Webster’s would define:
Value: Monetary worth
Cheap: Obtainable at low cost
In the context of investing, Value Investing SHOULD be defined by estimating companies’ intrinsic value, to estimate their monetary worth, and constructing portfolios from those trading below their intrinsic value.
Instead, unfortunately, ”value investing” has come to be defined by identifying companies that can be purchased at a low cost relative to some fundamental variable such as: earnings, book value, and sales among others.