I have recently been thinking about the link between long-term investing and value investing.
Generally, these two concepts are always mentioned in the same sentence, but does that really make sense? Value investing is based around buying businesses at a discount to their intrinsic value, as calculated conservatively. However, in traditional value investing, the style of investing Benjamin Graham is credited with inventing, stocks are usually sold when they become fully valued, however long that might take.
It could weeks, months or years, but generally speaking, value investors that follow the traditional style do not tend to buy and hold forever.
Even Warren Buffett (Trades, Portfolio), who is considered to be the world's most prominent long-term investor, does not buy and hold stocks forever. Data shows he has owned more than 2,000 equity positions over the past three to four decades, with the average holding period of each one being around one year.
The reason why he has developed such a reputation for being a long-term investor is that he keeps his winners and cuts his losers, so survivorship bias influences how we think about the Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) portfolio.
Value investing and mean reversion
There is no getting away from the fact value investing is built around the idea of mean reversion. A stock that has become cheap will move back to fair value eventually -- that is the theory anyway. It is difficult to see how a strategy built around this idea can be considered long-term focused.
At the same time, value investing is a lot more focused on valuation than it is quality. Indeed, as Graham once said, "There are no bad assets, just bad prices." This suggests he was willing to consider the most terrible businesses if they were cheap enough. For a mean-reversion play this makes sense, but you wouldn't want to buy and hold businesses for the long term just because they are cheap.
Value investing also requires a bit of market timing. Investing in high-quality businesses for the long term doesn't require too much consideration when it comes to price, as long as you are not paying over the odds, even acquiring a high-quality company at intrinsic value should generate attractive returns over the long term.
A large part of value investing is paying a low enough price to ensure a positive return, no matter what happens to the business. This requires some measure of market timing.
Looking for a catalyst
Looking back at the value investments Buffett made at the beginning of his career, as well as those made by Graham and other highly acclaimed value investors such as Seth Klarman (Trades, Portfolio), Walter Schloss, Peter Cundill and Bill Ruane, these managers were all looking for value with an upcoming catalyst. They wanted to buy cheap, but also realized that cheap stocks can stay that way for a long time, so they were looking for catalysts that would unlock value, a similar strategy to special situation investing. Finding a cheap stock and waiting for a catalyst is not a long-term strategy at all.
Having said all of the above, I will admit this is not a completely black and white debate. If you are lucky enough to find a high-quality business trading at a deeply discounted price -- the holy grail for value investors -- you can be a long-term investor as you are not relying on mean reversion, exactly the path Buffett has taken. But this strategy is much harder to follow than just finding cheap stocks, waiting for mean reversion and then moving on.
I don't think there is a right or wrong answer to this debate. I just think it is an interesting argument to consider that value investing and long-term investing have some key differences, though there is no clear set of rules for either.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
