Why We Invest the Way We Do
We are value investors. Value is defined as buying securities cheap relative to earnings and assets. This contrasts to growth where buyers are willing to pay a high price for companies with fast growing sales and earnings.
Why do we favor value? For two important reasons. First surprises tend to benefit value securities more than growth. Expectations are low for value securities, and when positive surprises happen the stock price can move up significantly. Positive surprises do not help growth stocks as much because investors are already expecting the good news. Conversely, negative news is already built into the price of value ideas so another negative surprise is not that “surprising.”
A second reason we favor value has to do with human psychology. People do not like being associated with losers, and they often sell these securities down to levels below which they ought to be, even under the worst of circumstance. Because of this, there is often a “margin of safety” built into the price of value ideas.
Value also outperforms growth over longer periods of time. The chart on the left shows the research of Eugene Fama and Ken French on stocks going back to 1927. Small and large value stocks have outperformed small and large growth stocks over the years.
Given the evidence you would think there would be many value investors. The fact is, however, there aren’t. The main reason is that professionals and individuals alike often lose their nerve when the going gets tough. Investors are too quick to sell a value strategy when it doesn’t work out just right. In short-term periods, where growth significantly outperforms value, it becomes difficult for investors not to jump on this popular, albeit expensive bandwagon.
Value investing requires patience, which often means sustained courage. We practice patience and stay focused on the long term build-up of capital, avoiding the short-term popular trends that can lead you astray.