The Value Of Value Investing - CFA Institute
THE VALUE OF VALUE INVESTING Stephen Horan, Ph.D., CFA, CIPM Managing Director, Credentialing CFA Institute
TODAY’S AGENDA Characterize Value Investing – Potential Benefits (Real and Imagined) Compare and Contrast Measures of Value Identify Value Index Construction Techniques and Their Implications Identify Barriers to Successful Value Investing Develop Techniques for Overcoming Barriers Conclude 2
CHARACTERISTICS OF VALUE INVESTING What does it mean to be “strategic” with value investing? What is the value investing opportunity on a risk and return basis? 3
THE ROLE OF VALUE INVESTING Investment versus Speculation “An investment operation is one in which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” - Security Analysis, Graham and Dodd, 1934 Grounded in Fundamental Analysis “Intrinsic Value” – Benjamin Graham Warren Buffet popularized Ben Graham’s legacy Seth Klarman popularized margin of safety Empirical Challenges to Market Efficiency Long-term price reversals (e.g., DeBondt and Thaler (1985), Foerster (2011)) Short-term and medium-term momentum (Jegadeesh and Titman (1993))
EASY TO FOLLOW VALUE INVESTING ADVICE “Strategic” Value Investing - Treating investments as if you were buying the whole business - Combining objective and subjective analysis Objective Analysis - Absolute and relative pricing models - Investment screens Subjective (Fundamental) Analysis - Macroeconomic analysis - Industry analysis - Company analysis - Based on expectations rather than hope 5
HISTORICAL ANNUAL RETURN CHARACTERISTICS, 1926-2015 – FAMA AND FRENCH Overall Large Market Growth Mid Small Value Growth Mid Value T-Bills Arithmetic Avg. 11.9% 11.4% 12.2% 14.7% 14.0% 16.4% 18.5% 3.5% Geometric Avg. 9.9% 9.4% 10.0% 11.2% 9.5% 12.8% 13.9% 3.4% Median 14.5% 13.2% 13.3% 18.6% 12.4% 18.3% 20.1% 3.0% Std. Deviation 20.1% 20.2% 21.0% 27.3% 32.6% 28.7% 32.2% 3.1% Skewness 0.432 -0.329 -0.053 0.261 0.938 0.443 0.249 1.017 Kurtosis 0.049 -0.342 2.514 1.978 3.484 1.523 0.402 0.986 0.419 0.392 0.416 0.412 0.323 0.452 0.468 0.000 Sharpe Ratio
GROWTH OF A 1 INVESTED FROM 1926 TO 2015 1,000,000 100,000 10,000 110,200 13,100 3,200 3,000 1,000 Large Growth 100 Large Value Small Growth 10 Small Value T-bills 1927 1931 1935 1939 1943 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 1 0
WHY DOES VALUE RETURN MORE THAN GROWTH? P 1 E r g P ROE B r g 8
BETA OF VALUE AND GROWTH STRATEGIES, ANNUAL DATA FROM 1926 TO 2015 Large Capitalization 0.97 Small Capitalization 1.40 Blend/Core 0.98 1.27 Value 1.23 1.36 Growth
HISTORICAL ANNUAL CORRELATION COEFFICIENTS, 1926-2015 Large Growth Large Growth Mid Small Value Growth Mid Value 1 Large Mid 0.85 1 Large Value 0.80 0.94 1 Small Growth 0.81 0.84 0.82 1 Small Mid 0.80 0.89 0.90 0.94 1 Small Value 0.73 0.86 0.90 0.87 0.96 1
VALUE AND GROWTH PERFORMANCE, 1981 TO 2012 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Large Small Growth Value Growth Value -7.13 12.8 -11.53 17.68 21.48 27.67 19.72 39.86 14.67 26.92 22.12 47.58 -0.72 16.17 -12.84 7.52 32.64 31.75 28.91 32.12 14.38 21.82 1.95 14.5 7.43 -2.76 -12.24 -7.12 12.53 25.96 16.63 30.76 36.11 29.7 20.58 15.7 1.06 -12.75 -17.74 -25.13 43.33 27.35 54.73 40.56 6.41 23.57 5.82 34.76 2.38 19.51 12.64 29.41 1.95 -5.78 -4.36 3.21 37.16 37.68 35.13 27.69 21.25 13.35 12.36 20.71 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Large Small Growth Value Growth Value 31.61 31.88 15.29 37.29 34.64 16.23 3.04 -8.63 29.43 -0.22 54.75 5.59 -13.63 5.8 -24.15 -0.8 -15.59 -1.18 0.16 40.24 -21.5 -32.53 -30.87 -12.41 26.29 35.07 53.2 74.69 6.53 18.91 12.54 26.59 2.82 12.17 5.45 3.53 8.88 22.61 11.67 21.76 14.08 -6.45 7.36 -15.21 -33.71 -49.03 -41.56 -44.39 27.91 39.15 34.45 70.54 15.87 21.61 30.66 33.54 4.14 -9.04 -4.32 -7.04 15.41 22.99 12.22 20.07
INDEX CONSTRUCTION Different methods lead to different results Construction methods underestimate the value of “strategic” value investing 12
FAMA-FRENCH PORTFOLIOS OF ALL CRSP STOCKS BASED ON NYSE BREAKPOINTS AND P/B Percentile of NYSE-Listed Stocks 100% 90% VALUE CORE GROWTH 30% 40% 30% 80% 50% 70% 60% Large Cap Small Cap 50% 40% 30% 50% 20% 10% 0% Fama-French 13
IBBOTSON PORTFOLIOS BASED ON NYSE, AMEX, AND NASDAQ MARKET CAP AND P/E 100% Percent of Market Capitalization 90% VALUE CORE GROWTH 1/3 1/3 1/3 80% 70% 70% 60% Large Cap Small Cap Mid Cap Excluded 50% 40% 30% 20% 10% 20% 7% 0% Ibbotson-Morningstar 14
ALL “VALUE” IS NOT CREATED EQUAL: ANNUAL RETURNS FROM THE YEAR 2000 Large Small Growth Value Growth Value Fama-French -13.63 5.80 -24.15 -0.80 Ibbotson Associates -22.01 -3.00 -22.60 22.69 15
VALUE INDICES Index Description Russell 1000 Value Index Russell 1000 (large cap) companies with lower price to book ratios and lower forecasted growth rates Russell 2000 Value Index Russell 2000 (small cap) companies with lower price to book ratios and lower forecasted growth rates S&P 500 Value Lowest 1/3 of S&P 500 based on lower growth factors (EPS, Sales and Price) and higher value (lower P/B, P/E and P/S) RAFI 1000 Fundamental Index based on Sales, Cash Flow, Book Value and Dividends 16
BERKSHIRE HATHAWAY 17
PRICE-EARNINGS RATIOS OF NYSE-LISTED STOCKS, 1951-2015 100 90 80 70 60 Percentile June 2015 P/E Ratio 5th 30th 50th 70th 95th 8.2 16.0 19.8 25.6 87.0 95th 70th 50 50th 30th 40 5th 30 20 10 0 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 Source: Eugene Fama and Kenneth French Data Library 18
CHALLENGES TO VALUE INVESTING Value investing requires discipline and fortitude Some obstacles are external. Some are within us (e.g., cognitive and behavior biases) Techniques to overcome the obstacles 19
WHY DO WE DO THIS?
CONFORMITY – INFLUENCE OF PEERS EVERYBODY ELSE IS DOING IT 21
CONFORMITY – INFLUENCE OF AUTHORITY YES, SIR! 22
WHAT’S ON YOUR MIND? Mary is quiet, studious, and concerned with social issues. While an undergraduate at Berkeley, she majored in English literature and minored in environmental studies. Which is most probable? a) Mary is a librarian. b) Mary is a librarian and a member of Green Peace. c) Mary works in the banking industry. 23
I REALLY HATE TO LOSE MONEY 24
EVEN THE SIMPLE ONES CAN TAKE A WHILE TO CONVERGE 25
OVERCOMING OBSTACLES: IPS AND INVESTMENT DIARIES 26
OVERCOMING OBSTACLES: SUNK COSTS, TRADING, AND LEVERAGE 27
CONCLUSIONS Value investing is a time tested investment strategy Return differentials are substantial. They are partially offset by risk and implementation challenges but not entirely. Measuring value is not a science, but an art, and the definitions matter. Value indexes under estimate the “strategic” value investing opportunity Any value investing approach requires large doses of intellectual and emotional discipline. Structured implementation helps. 28
Value investing is a time tested investment strategy Return differentials are substantial. They are partially offset by risk and implementation challenges but not entirely. Measuring value is not a science, but an art, and the definitions matter. Value indexes under estimate the "strategic" value investing opportunity
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Le genou de Lucy. Odile Jacob. 1999. Coppens Y. Pré-textes. L’homme préhistorique en morceaux. Eds Odile Jacob. 2011. Costentin J., Delaveau P. Café, thé, chocolat, les bons effets sur le cerveau et pour le corps. Editions Odile Jacob. 2010. 3 Crawford M., Marsh D. The driving force : food in human evolution and the future.
