What I have noticed over the past few years when writing about the investment world and strategies of famous investors is that every so often, around every six months, an article is published claiming that value investing is about to make a dramatic comeback.
Every time, these articles use reasonably similar arguments to justify why value investing is about to regain traction. These usually revolve around the high prices of high-flying tech stocks and low prices of value stocks.
But what is so often missed from these articles is the fact that value investing has actually changed substantially over the past few decades, and so has investing in general.
Investing has changed
The career of Warren Buffett (Trades, Portfolio) over the past seven decades or so is a fascinating guide as to how the world of investment has changed.
Buffett started investing with deep value stocks, buying stocks trading at a significant discount to the value of the net assets and profiting when the market re-rated the equities. However, in the '70s and '80s, his strategy changed, moving away from deep value towards value and quality. Since then, you can argue that his approach has changed even more. Today he is not so much focused on buying cheap stocks but instead purchases good franchises and strong brands that have the power to generate steady cash flows for investors for many decades without being disrupted.
The question is, then, where does this leave the average value investor?
What is value today?
Buffett's strategy has had to change and adapt as Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) has grown. He can no longer invest in the bottom section of the market because he has so much capital; the opportunities in this part of the market are just too limited to produce acceptable returns for Berkshire Hathaway's investors.
Most everyday investors don't have this same problem, but another problem that has emerged over the past two decades is the availability of information. Today it is easier than it has ever been to find financial data on companies and gain access to crowd-sourced research. Any investor anywhere in the world can obtain research on companies with just a click on sites such as GuruFocus.
These changes have helped convince me that value investing, in the form Benjamin Graham conceived initially, is dead and is unlikely to return. Markets are vastly more efficient today than they have ever been before, and the sheer number of people following a value strategy and using powerful tools to comb the market for undervalued equities means gaining an edge in the crowded market is extremely difficult.
That's not to say that you can't still find undervalued equities. I know for a fact there are plenty of highly skilled fund managers out there looking, quite successfully, for deeply discounted securities. The difference between these managers and the strategy Benjamin Graham favored is that each opportunity is not just cheap (in some cases these positions are not cheap to buy traditional standard at all), but there are other factors to consider. In each scenario, a deep understanding of the market and a company's potential is required. A well-established and well-researched circle of competence, therefore, is now more essential than ever before. Almost none of these managers is buying stocks just because they are cheap.
As entrepreneurs and hedge fund managers continue to develop ever more efficient ways of trying to beat the market, it looks as if the problems value investors have are only going to become harder to navigate.
That being said, the outlook for value investing really depends on when the next bear market emerges. But with market efficiency improving, could it be the case that the next bear market is a more managed affair? Will investors dump everything as they did in 2008 when so many firms escaped the financial crisis without a scratch and went on to achieve fantastic returns for investors? Only time will tell.
The point is, it is now more critical than ever before to know what you are buying, and if you don't understand, avoid the situation altogether. Buying a cheap stock just because it is cheap is no longer a guaranteed way to returns. With so much financial data available to investors of all types today, that cheap stock is probably cheap for a reason.
Disclosure: The author owns shares in Berkshire Hathaway.
