Value investing is dead. Long live value investing. ?

For the uninitiated here is a simplistic sidenote on what is a value stock? Say a company has a market cap of Rs 100 Crores based on the current market price. Your analysis looking at the companies assets, liabilities, current and future prospects and at other companies in the same industry leads you to value the company at Rs 200 Crores. You have a “value” investment in your hand now – you can buy the company at Rs 100 Crores market cap and wait for it to reach your calculated value of Rs 200 Crores and then sell it at a handsome profit.

From the above example, a few things fall out immediately.

1/ Price (i.e the Rs 100 Crore market cap) is given and observed by everyone from the market.

2/ Value, however, is subjective. A company that one investor values at Rs 200 Crores based on their methodology could be valued at Rs 50 Crores by another using a different methodology.

3/ There is no guarantee that the market will come around to your viewpoint and that the market cap of the company will increase to Rs 200 Crores.

4/ Even if the market cap rises to Rs 200 Crores it may take a long time for the value gap to be realized. This is the classic ‘the market can remain irrational longer than you can remain solvent’ saying attributed to Keynes.

The methodology continued to be refined with small-cap value finding favour through the 80s and 90s after the small-cap effect was first documented by Rolf Banz. Fama & French popularized a quantitative measure of value investing that made it easy for almost anyone to practice it. What is hard about buying the lowest price to book stocks in a given industry? Anyone with decent data and a spreadsheet could do that. And they all did, driving a lot of investors into this style. Value investing became less “contrarian” and more “mainstream”.

At the turn of the century value investing hit a snag maybe because it became so popular. As more and more investors pile on into a strategy the returns from that strategy tend to moderate. Returns to the value factor and even the small-cap value factors have been diminishing since then. Practitioners have to keep on modifying there core tenets of what constitutes a value stock to derive any value from value investing 🙂

And of course value investing has completely missed the mega-cap tech rally after the 2008 financial crisis.

How bad is it? In the chart below we look at Vanguard growth ETF vs Vanguard value ETF.