Value “Investing” Always Works Even When The Value “Factor” Falters

I couldn’t begin to count how many times over the past couple of years I’ve heard or seen negative commentary regarding Value (and I’m sure if you comb through my own writings, you’ll catch me as having done it). Some say Value is dead. Some say it’s been dead for a long time. Others say it’s just cold. Others say things that can’t be printed. I propose a (slightly belated) New Year’s resolution. Let’s be clear about what we mean. Do we mean the Value “factor,” which has, indeed, been frosty? Or do we mean Value “investing” which has been just as sound and successful as it ever was and may well be the only logical way to invest? The distinction is not just a matter of verbal nit-picking. It goes to the heart of quantitative investing and how we contextualize(and invest based on) factors.

© Can Stock Photo / ChristianChan

First Things First: Value Investing ALWAYS Works

Imagine a world in which value investing did not work: Investors might pay, say, $65 for a stock that’s worth only $40.

“Big deal, that happens all the time”, one might say. Look what happened at the turn of the century leading up to the dot-com crash. Look what happened to FANG stocks just recently. Look what happened to...pick another example; market history is littered with anecdotes like those. We can even talk about the centuries-ago tulip craze.

And speaking of tulip bulbs, was that mania really an example of buyers ignoring value? Imagine you’re a Dutch collector as the market was rallying and approaching its peak. You’re about to buy a set of tulip bulbs for 500 Ws (Ws is a unit of currency I just invented — Whatevers — to spare me the burden of looking up the actual prices in terms of the actual currency). That’s a steep price compared to a year ago when the same set of bulbs would have fetched, say 150 Ws. Just as you’re about to make your purchase, another seller offers an identical set of bulbs a 485 Ws. “Is the market now falling,” you ask. “No. I have a more cost-efficient operation and can afford to offer the same goods at lower prices,” the second seller says. He continues to explain that he’s honing his craft to prepare for the 20th Century when he plans to reincarnate on the other side of the Atlantic as a guy named Sam Walton.

© Cam Stock Photo / masyusha

What would you do? Will you pay Sam Walton’s spiritual (and fictional – please don’t try to fact check this) ancestor 485Ws, or will you continue on your way and pay 15 Ws more than you need to pay to the other dealer for the same bulbs.

If your brain is wired similarly to the brains of the gazillion or so future humans who made Walmart the giant it became (not to mention Vanguard, E*trade, etc.), you’re going to get the best price you can for the goods or services you’re buying. So you’re into Value. That’s so even if tulips wind up selling for just 12 Ws a few years later.

Buyers always want good prices for what they get. That’s so even for U.S. shoppers who didn’t patronize Walmart and pay more elsewhere. If they pay more, they got more. Maybe it’s about convenience, service, better return privileges, a more pleasant shopping-day experience, or even snob appeals of being perceived as one who need not stoop down to standing in line at Walmart. Whatever the case, all buyers want the best prices for what they perceive themselves to be buying.

It’s The Same In Finance

The same holds true in the financial markets. Would you pay me $1.05 to buy a $1.00 bill from me? (If so, ping me privately to arrange a meeting, and give me time to get to my bank to obtain a lot more singles than I usually carry with me). Assuming you’re not a crazy person or one who is so anti-value you’d do anything to try to prove me wrong here, you’ll decline this offer because you know how much a $1.00 bill is worth, the time value of such a purchase, and the risks inherent in actually getting the benefit of what you buy. Based on all that, you want me more than a dollar (although you’d back up the truck if I were nutty enough to offer singles for $0.90).

A $1.00 bill is a financial asset, just like commercial paper, debentures, preferred stock, common stocks, etc. We never want to pay more than we think the asset we’re buying is worth. We’re human. This is inherent in the way we’re wired, even with common stock. Imagine yourself back in the days before online trading, when you had to deal with a human broker. Imagine you want to buy 100 shares of XYZ that last traded at 74 1/4; (Does anybody miss the good old day, with fraction-based pricing?) Your broker is in touch with two 100-share lots; one offered at 74 5/16 the other at 74 1/2 and asks which you want to buy. Is there any way you’ll not pick the $74 5/16 lot? It’s so obvious you will, that such conversations didn’t actually happen. It was presumed your broker would sell you the 74 5/16 lot, and automated trading algorithms do likewise today. Even with stock, you want the best price for that which you are buying.

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