As defined by Stockopedia, value investing is extremely simple in theory, but tougher in practice. If you compare the price of a stock with a confident valuation of its true worth (intrinsic value) and find you can buy it at a considerable discount (margin of safety) then you may be onto a winner. But value investing is much harder than it looks for two reasons, firstly the real intrinsic value of a company can be tricky to calculate but also the practice of buying beaten down stocks also runs contrary to almost all human instincts. Who wants to be the guy holding the bombed out engineering stocks when everyone else is buying Apple? But it’s precisely these tendencies that lead to so many investors over-reacting, driving prices down so low that value stocks become so profitable in future.
The main reason behind their trendiness today is thus an extension of what it is able to do. Following the increased fear due to the financial crisis of 2008, where derivatives became a dirtied word associated with “greedy” wall street “wolves”, people are now more favoured towards value investing.
Not only so, when comparing between the risks and returns, most people think that there would be rosy returns when doing value investments. The image that value investments bring is that the returns would remain decent even when trading something of lower risk. Yet, that may not be true depending on whether the individual has made the correct decisions and valuations.
Unfortunately, despite the huge evidence that value strategies work, it is unlikely that a well thought-through value-based investing approach is being put to work for you and your family or anyone else that saves money in an actively managed fund. A mountain of research suggests that active fund management is riddled with bad decision making, herd behaviour and excessive compensation leading to significant underperformance. The extraordinary truth is that 75% of actively managed funds underperform their benchmark over the long term due to the cost of high and often under-disclosed fees.
Individuals who do have the time and discipline to do their own research are generally going to be better off taking investing matters into their own hands. There are cheap, neglected, misjudged stocks out there and with the right techniques up your sleeve it isn’t so hard to find them and profit from them.