Value Investors Are Vexed

Value investing is simple in theory, difficult in practice.

Ben Johnson 18.04.2019
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The concept of value investing dates back at least as far as the 1920s, when Benjamin Graham and David Dodd first began teaching finance at Columbia University. The fundamental principles of value investing were later enshrined in the duo’s classic “Security Analysis,” first published in 1934.1 The idea is painfully simple: Buy securities at prices below their intrinsic value and wait patiently for their market price to reflect their true worth. Or as my grandfather used to tell me, “Investing is simple, buy ‘em cheap and sell ‘em dear. Did I mention that it’s not easy? Good luck!”

The approach, so elegant in its simplicity, ultimately evolved into a religion of sorts. Many of Graham and Dodd’s disciples, most notably Warren Buffett, rank among the most successful investors of all time. However, despite having basic intuition and legions of followers on their side, it wasn’t until 1992 that Graham and Dodd’s theory gained a rigorous empirical backbone. That was the year Eugene Fama and Kenneth French published their seminal work, The Cross-Section of Expected Stock Returns,”2 which introduced the concept of the value premium. The pair found that stocks trading at low price/book multiples tended to outperform those trading at high multiples over long time horizons. Fama and French showed that value was real, it was significant, and it could generate excess returns. However, their version of value was hatched in academia, a realm free of pesky issues like fees, trading costs, and taxes—real-world problems that might affect investors looking to harness the value premium.

Value “style” indexes were ultimately born out of these ideas. These indexes were at first designed to be style-appropriate benchmarks for active managers, and it was only later that they were adopted by index funds and exchange-traded funds. Their perfor­mance can give us a sense of the real-world value premium available to investors. From Dec. 29, 1978,3 through Feb. 28, 2019, the Russell 3000 Value Index gained 11.97% on an annualized basis, while the Russell 3000 Growth Index grew by 11.20% annualized. This 0.77% annual value “premium,” compounded over decades, netted a substantial increase in ending wealth. A US$10,000 investment in the value index grew to US$937,759.17 as of the end of February. The same US$10,000 invested in the growth index yielded US$711,476.79—a 32% difference. Clearly, Graham and Dodd were onto something.

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Ben Johnson  Ben Johnson, CFA is the Director of Passive Fund Research with Morningstar.

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