What are the pro's and con's of value investing?
Do you think it's a worthwhile strategy or are you more of a "efficient market" proponent...please explain.
Best Answer
699 points
7million7years answered 2 years ago …
Value Investing means "buying something worth $2 for $1" ... well, not exactly, but you get my point: buying something for less than it is WORTH.
Now, this is a critical distinction: just because something was selling for $2 last week, and is selling for $1 this week, doesn't mean that it is a VALUE Stock ... it may only be 'worth' $0.50 and the market may simply be driving the price down to that ... and, beyond!
In fact, that same stock (really 'worth' only $0.50) may BECOME a Value Stock if/when the market overshoots and sends the price down to $0.25.
The problem with Value Stocks is then one of KNOWING what they are truly worth at any point in time, and only buying when they are selling for a price less than that (preferably, with a large Margin of Safety ... which simply means, buying it for MUCH LESS than what you THINK it is worth "just in case" ...).
Now that we have covered the basics, what is the PRO of Value Investing?
Exactly that ... being able to buy something 'worth' $2 for only $1. I can't think of a better, more sure way of making money than that!
Then, what is the CON of value Investing ... after all, there must be some or we'd ALL be doing it?
Simple: as I said before, it's all about KNOWING which stock that is currently selling for $1 is actually worth $2 (and, avoiding the ones that are only worth $0.50!!). And, that takes some knowledge and skill. Warren Buffett has that knowledge and skill ... so do many others, to a greater or lesser extent.
One other CON - one that is, ironically enough, addressed by this week's other TickerHound Question: "Is technical analysis still applicable in a "news driven" market like the one we're in now?":
If a stock that you KNOW is worth $2 is currently selling for $1, is it an automatic BUY?
Well NO ... you see, you KNOW it is worth $2, but the rest of the market may not!
Or, it may have BEEN worth $2 but there is something happening (maybe a pending lawsuit around a key patent, or the loss of a major contract, or ... ) that YOU don't know about because it hasn't hit the "news" (or TickerHound) yet, but those 'in the know' are selling off the stock by the truckload.
So, that's where technical analysis is not just applicable in a "news driven" market like the one we're in now, but absolutely CRITICAL for buying Value Stocks ...
... it will tell you WHEN to buy (or sell off) that stock holding, based upon what the "insiders" are doing.
If you want to learn more about Value Investing, and using Technical Analysis to know when to get in/out of a Value position, I recommend picking up a copy of Phil Town's excellent primer: Rule 1 Investing ... and, Good Luck!
Answers
4087 points
EthanR answered 2 years ago …
I think the main pro is that you are buying a stock/ETF/sector when the price is considered low. One can make a nice profit, if you are willing to buy and hold for a long time. The main con is that the price is low because it is out of favor, and it may be a long time before you begin to see price appreciation. One has to be very patient and willing to tie up their money for quite awhile for rewards in the future.
Personally, I would rather try to find stocks/ETF/sectors that are performing better right now and wait for the value stocks to start doing better. Let's take Ford (F) for example. Six months ago, it was trading around 7.75-8.00. Based on historical prices, one could say that F was a value stock. But it spent the next four months in decline, finally bottoming in the 5.00 area in March. Today it is back up near 8.00. So basically, if you bought it six months ago, you had dead money. Of course if you bought it in March, you are in profit city. So when was it a "value"? Were the fundamentals that different between November and March? Probably not, but the price was ridiculously different.
Right now people say that Financials are value stocks. But Citigroup was a $25 stock in January, and today at the end of April, it is a $26 stock. One could have made a lot more money in the past three months if they had money in XOM, for example. XOM, not really considered a value stock, rose from 84 to 92.50 during that time.
If one is going to buy value stocks, I think the best value stocks to buy are the large, well known companies, during time periods when they are out of favor. Run a 10 year chart on stocks such as MO, DIS, and X. You will see that each of them was out of favor at one time, and have now produced enormous profits for value investors who were savvy enough to buy near the bottom. You could have bought X for $9 in 2003. It closed this week at 152.48!
249 points
engcomp answered 2 years ago …
The points made by Ethan and 7m7y are illustrated by Bear Sterns. Have a look at this chart:
http://uk.finance.yahoo.com/q/bc?s=BSC&t=1y
You will see that it rallied when the price dropped from 150 to 100. Another rally happened when it hit $75. Seems some folk thought that BSC was good value on each of these occasions.
Now that BSC is $10, I think it was good value at $2. Is it still good value at $10? Only if it survives, which is by no means guaranteed.
4107 points
MNSL answered 2 years ago …
Value investing is one of the most successful investment strategies, and its success verifies not only its validity but its competitiveness, compared with modern portfolio theory based on the efficient market hypothesis.
Value investors can find attractive opportunities in bull markets as well as in depressed markets.
They look for stocks pushed down too far, or the stocks that have been neglected. I think that this strategy holds across market cycles. You can survive the ups and downs of the market.
In other words that value investing works in both contraction and expansion market although that value investing is more valuable during the contraction period.
Value investing generates higher returns than growth investing. Some study has found out that stock with high valuation ratios generated higher returns than stocks with low valuation ratios.
By applying value philosophy with discipline you can build up not just a profitable, but and exceptionally profitable investment. You can get steady, consistent gains that outperform the S&P 500.
In addition, value investor will not follow hot stock tips and mass market mania and reduce risk of underperforming stock portfolio by building safety net.
In active investment most strategies do not work. You will diminish benefits of actually buying good quality shares. In addition you will get only around 12% return on actively managed portfolio. On the other hand if you invest in value portfolio you can get over 25% returns. Currently some investors who invested in Growth funds switching their investment to other funds in some countries. In addition some funds disposed their holding at a loss. If they had followed value approach they would have sold their holding when market was peak and overpriced.
Similarly top value investors in housing market sold their valuable houses in 2005 and 2006 through out the world when the market was peak and when they realized housing sector is overpriced. Once they see 30% to 50% strong correction they will enter the market again. In fact still housing sector is over priced more than 50% in some countries.
You can apply value approach almost all type of stocks to cyclical stocks, hidden gems, neglected stocks and large cap stocks. Even during corrections, when buying on bad news and buy back programs you can make use this value strategy to make above average returns.
Some cons of value investing:
Proponents of the market efficiency theory suggest that value investing must generate high returns to compensate for their high risk.
They also suggest that the superior performance of value investing relative to growth investing is due to investor irrationality.
The potential returns for value investing are smaller than those of growth investing
However some studies and the evidence have found out that it is still worthwhile to invest in stocks with high valuation ratios during periods of contraction as opposed to investing funds in growth stocks. When we apply growth approach sometimes we will buy overvalued stocks. Safety net is low. During market downturns growth stocks will perform very badly and there will be potential for total loss.
