Value investing is currently a relatively unpopular strategy. Many investors appear to be more interested in a company's earnings growth forecasts rather than whether it trades at or below its intrinsic value.
However, in my view, a value investing strategy can outperform other investment styles in the long run. It has been used to great effect by investors such as Seth Klarman (Trades, Portfolio). The Baupost Group co-founder's long-term outlook and ability to ignore other investors when searching for value investing opportunities may be key reasons for his consistent market outperformance.
Value investing in a bear market
The stock market has gained 50% since reaching a nadir in March. However, the current bull market is unlikely to last forever. The past performance of the S&P 500 shows that the average bull market lasts for around 1,000 days. Therefore, recent stock market gains may persist for some time, but are unlikely to be maintained over the long run.
A value investing strategy can lead to a more efficient portfolio allocation ahead of a bear market. It allows an investor to avoid overpriced stocks that could be hurt to a greater degree than their cheaper peers in the next market downturn. It also provides greater scope for capital growth, since companies are purchased at prices that are below their intrinsic values.
Klarman has previously acknowledged the usefulness of a value investing strategy during bear markets. As he once said:
"It is crucial to have a strategy in place before problems hit, precisely because no one can accurately predict the future direction of the stock market or economy. Value investing, the strategy of buying stocks at an appreciable discount from the value of the underlying businesses, is one strategy that provides a road map to successfully navigate not only through good times but also through turmoil."
Adopting a contrarian stance
A value investing strategy encourages investors to adopt a contrarian standpoint. In my opinion, this is likely to be a beneficial exercise over the long run because the investment community often overreacts to current market conditions.
For example, investors may become overly optimistic during a bull market. This can lead to excessive valuations for companies that do not factor in the potential risks that they face. Likewise, ignoring your peers through using a value investing strategy can be useful in a bear market. It may strengthen your resolve to buy unpopular stocks at low prices.
It is never easy to go against the views of your peers. However, as Klarman previously said:
"It is always easiest to run with the herd. At times, it can take a deep reservoir of courage and conviction to stand apart from it. Yet, distancing yourself from the crowd is an essential component of long-term investment success."
A long-term payoff
Value investing may continue to be a relatively unpopular strategy among many investors in the short run. They may remain more interested in a company's short-term growth prospects than in the potential for quality businesses to trade at prices closer to their intrinsic values.
However, in my view, using a value investing strategy is likely to pay off over the long run. It has a consistent track record of success across a variety of market conditions. Therefore, it is likely to become more popular among investors over the long run. This may mean that today's cheap stocks benefit from rising demand among increasingly value-focused investors.
As Klarman once said, "A value strategy is of little use to the impatient investor since it usually takes time to pay off."
Read more here:
- Peter Lynch: 3 Reasons to Buy Stocks Amid Economic Uncertainty
- Howard Marks: An Uncertain Outlook Can Produce Buying Opportunities
- Warren Buffett: A 'Dull' Investment Strategy Can Be Profitable
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