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Today’s Pronouncement: Value Investing Is A Lie

April 16, 2011 | About:

David Chulak

29 followers
Perhaps most of you are more proficient than me about removing your name from unwanted investment websites. Typically, I will delete them en masse on a Saturday morning. Early this morning, my curiosity was piqued when I saw the headline, “’Buy Low, Sell High”, is a Lie”. The article was written by Steve Reitmeister from Zacks.com, Executive Vice President of Zack’s, who went on to admit:

Before you write me off as some kind of heretic, let me clear something up. I am actually a diehard value investor. And yes, for a long time I bought in to the allure of buying low and selling high as the road to investment success.

Value investors will offer different examples or definitions of what value investing is to them, however; there are points on which I believe we all agree. Buying a stock at a discounted price that provides us with a margin of safety which limits the risk of the investment or improves our likelihood of preserving our capital - a main goal. Today, I learned that this style of investment really doesn’t work.

Actually, my early investing days were strictly a momentum style, not too much dissimilar from the style Mr. Reitmeister goes on to describe. Having discovered Benjamin Graham, Warren Buffet, Joel Greenblatt, Seth Klarman and others many years later, the truth is, I am unable to ever go back. Occasionally, Mr. Market get things a little crazy and you will discover stocks that suit both styles of investing, but this is an accident and tells us nothing about the stock. I will maintain decorum and not refer to this style Mr. Reitmeister promotes as speculation. Ok, it is speculation.

For instance, I currently am long on PDL Biopharma (PDLI) and ViroPharma (VPHM). PDLI is held by Seth Klarman, Joel Greenblatt and Jean-Marie Eveillard. VPHM is held by Joel Greenblatt. If you go to the Investor’s Business Daily website and research PDLI, you will discover that no “growth” style investor would probably touch it. I’m up nearly 12% in 1 ½ months. I’ll just buy some more when it dips. They don’t need to buy it. VPHM, because the stock has been going up since….well, the first day it started going up…..is loved by the website and has a Composite Rating Score (the most important rating) of 99. This is the top score a stock can receive. Does this really mean anything? Does it give me more reason to buy VPHM? No. Why would it? After buying it, it went up. I want all my stocks to do that. When it started going up, the momentum crowd says “buy”.

Ken Fisher discusses stock price movements in his book, “Debunkery”. He states:

Think this through: If stock price movements dictated later movements, you could just buy stocks that have gone up a bunch. But you know instinctively, that doesn’t work. Sometimes a stock that up a lot keeps going up, sometimes it goes down, or sometimes it bounces along sideways….

There’s a school of trading dedicated to momentum investing. These folks believe (contrary to a vast body of scholarly research) that price movement is predictive. They buy winners and cut losers. They look for patterns in charts. But momentum investors don’t do better on average than any other school of investors. In fact, they mostly do worse. Name five legendary ones. Or even one!

I would suggest to all investors, that they add another book to their shelf which will forever convince you of the wisdom known as value investing. Read “Value Investing – Tools and Techniques for Intelligent Investment” by James Montier. It is a highly technical but very readable and somewhat irreverent book that places all styles of investing under a microscope.

About the author:

David Chulak
David Chulak is a private investor that uses a value approach to investing in the styles of Graham & Dodd and Warren Buffet. Looks for that margin of safety in an effort to preserve capital and attempts to guard against short term market fluctuations by having clear rules laid down in advance for selling an equity. Likes to visit the company's where his investments are in order to understand the business better.

Rating: 4.0/5 (3 votes)

Comments

LwC
LwC - 3 years ago
According to Bruce Greenwald, studies show that the two investment methods that when well executed consistently outperform the market averages, are momentum and value.

"Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it." -- Will Rogers

davidchulak
Davidchulak premium member - 3 years ago
Let me clarify something. As a former "momentum" investor, I have no issue buying a value stock that has price momentum going it's way. I actually own a couple. I'd be a fool not to. But trying to pick a stock that has momentum would and should be secondary. I want my margin of safety first and always.

Greenblatt does acknowledge success for some momenum investors such as O'Shaughnessy, ,but goes on to add that, "....momentum plays out fairly quickly". I suggest that if you really look at O'Shaughnessy's record. You will discover a less than stellar performance.

superguru
Superguru - 3 years ago
I am a value investor of Schloss style.

What are some best practices and techniques from momentum and technical trading world which we value investors can adopt?

I believe in taking what is best and useful from each discipline just as Buffett combined Fisher and Munger with Graham to become even better.

@DavidChaluk as you came from that style may be you can guide us.

Alex Morris
Alex Morris - 3 years ago
Great article! James Montier's "Value Investing" is the best book that I have personally read about the merits and practice of value investing.
davidchulak
Davidchulak premium member - 3 years ago
Let me clarify some more. What is being promoted is a system where a stock has:

1. Earnings momentum

2. Technical momentum

3. Value

This can best be demonstrated by using a stock recommended by Zack’s under this system. The stock is Netease.com (NTES). The stock has undoubtedly gone up since the first of this year. It has been a great stock for someone. Interestingly, if you check GuruFocus, you will note that the last guru holding this stock sold off nearly 85% of his holdings at year end. No other guru holds the stock. Why?

The Fair Value Calculator at GuruFocus indicates a value of $ 44.65. The current price is $ 52.78. I ran some numbers quickly and get a number around $54.00. I suggest that one of the reasons that gurus aren’t in line to buy is because it’s not a good value at this time. Someone will come along now and tell me they have a higher number. That’s all well and good. I only use my number….you get the idea…I hope.

The article addressed earnings momentum thusly:

“When companies are experiencing positive earnings momentum, it means that most everything is going right..” (Really???)

It goes on to say that the “best way to uncover earnings momentum is to find stocks enjoying large upward estimate revisions”.

So, once again, we are being asked to accept the future estimates that an analyst throws out to the crowd. This is what we hang our hat on? Not cash flow or free cash flow, but unknowable future earnings upward revisions?

Technical momentum is described by Zacks as equivalent to Newton’s law….that is… a body in motion tends to stay in motion. Unfortunately, Newton’s law was actually “adjusted” by Leonard Euler in 1750. Further, I am terrified that we might be following Newton’s investment advice. As many of you are aware, he lost a fortune in the South Sea Bubble. He explained, “I can calculate the movement of the stars, but not the madness of men”. It’s the madness I’m afraid we are being told to follow.

As a stock goes up in price, our margin of safety dwindles. This obviously is what happened with NTES. Because it’s gone up for several months and is equal to its intrinsic value….I’m supposed to invest in it?

If my margin of safety is gone, there is no way for me to preserve my capital.

Bottom line: You don't start picking a stock because of the direction it's headed. You pick it because of it's value. Montier....Fisher....Graham....Buffett.....Greenblatt....Gabelli....Klarman...these are the stars that you need to follow.

LwC
LwC - 3 years ago
Davidchaluk,

Please allow me to clarify that I was only trying to point out that according to Greenwald, he has reviewed and accepted the results of certain studies that show that a well executed momentum investment strategy will on average out perform the market averages.

Greenwald refers to O'Shaughnessy: "Choosing a portfolio of last year's best performing stocks is a bet that winners will continue to excel. From 1952 through 1994, the top 50 stocks selected on the basis of relative strength bested the market as a whole by an average of 3.7 percent a year." Regardless of that conclusion, as we all know Greenwald teaches and advocates value investing, not momentum investing.

I don't know if you intended to quote Greenblatt (as you wrote above) or Greenwald, but Greenwald did continue his comments with the statement: "But momentum plays out fairly quickly." I don't know if Greenblatt also wrote that. However if you were quoting Greenwald, you left out the context which IMO is important since he also wrote "When stocks are selected on the basis of price change over three prior years, rather than last year alone the results are different: The worse do better." IMO that does not change the apparent conclusion that a momentum strategy that is executed over the shorter period of a year instead of three years will on average out perform the market. You appear to imply a different conclusion, and you are of course free to make your own conclusion.

I was not endorsing momentum strategies as preferable to value investing strategies, nor did I intend that my remarks be derisive or critical of your own experience and comments. I apologize if my comments offended you.

Good luck.

davidchulak
Davidchulak premium member - 3 years ago


Thanks for the correction. You are correct. I said Greenblatt, but meant Greenwald. Don't ever be afraid to correct me, nor was I offended. We are all learning daily.

Thanks for the kind words.

In the latest edition of the Intelligent Investor, Jason Zwieg has some interesting comments regarding O'Shaugnessy's strategy.

I will be the first to admit that I look at the direction of a stock. If it's headed up, I just want to be very careful on my margin of safety because it can disappear so fast. (Momentum!!) My VPHM was headed up when I bought it. But that's not why I bought it. If it has been headed down....I watch it also to see how my safety net is working.



_

LwC
LwC - 3 years ago
LOL

Following your suggestion I readre-read Zwieg's comments about O'Shaugnessy. It reminded me of Graham's comments about Dow Theory in The Intelligent Investor, and since I had the book in my hands, I re-read them. I guess some things never change.

Thanks for bringing that to my attention.

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