Investing in deep value is not as easy as looking for cheap stocks and then buying them. As the head trader at a firm I worked at used to say: “If it were easy, everyone would do it.” Yes, understanding the technical ins and outs of what makes a stock cheap relative to its intrinsic value is a necessary prerequisite for success in value investing, as is having a deep understanding of accounting principles and an ability to read financial statements. But there is also a well-known psychological component to value investing that is an inherent part of its contrarian strategy.
It’s lonely to be alone
Looking for deep value means often means investing in companies that may have very bad press around them, companies that may have mediocre management, companies that may be in the process of a painful restructuring. In other words, it means throwing your lot in with people and situations that most others would stay far away from.
Of course, not all value investors dive quite so deep. Warren Buffett (Trades, Portfolio) famously pivoted away from this "cigar-butt" strategy early in his career and is now quite content with buying “wonderful businesses at fair prices," rather than “fair businesses at wonderful prices.” But many of those who follow Ben Graham-style investing to its logical conclusion do end up looking for such bargains. Accordingly, a portfolio constructed entirely of such bottom-of-the-barrel stocks is likely to cause at least some level of psychological distress.
Most people do not like to be uncomfortable. They do not like being mocked or ridiculed for their investment decisions. As writer and investor John Mihaljevic says in his book, "The Manual of Ideas:"
“Most of us find it easier to accept a mistake if we can do so in good company. Investing in Enron and losing money may make us feel less bad because many smart people suffered the same fate. However, if we lose money in a company that has been widely panned by analysts and shorted by the smartest hedge fund managers, we may feel especially inadequate.”
This peer pressure can cause investors to pass up on bargain deals even when they are staring them in the face. And it’s very clear where this comes from. Most people want to believe that investment analysts and financial advisors know what they are doing. Assuming a contrarian position means undercutting that belief, and that is uncomfortable.
Perhaps it might be better to think of comfort as something that an investor pays a premium for. In the same way that holding cash in a bank account provides a pretty strong guarantee of safety (whilst yielding minimal returns), so also might a strategy of buying "comfortable" stocks that everyone knows carry with it a premium in the form of foregone returns.
Disclosure: The author owns no stocks mentioned.
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