The most significant market anomaly that has emerged over the past 10 years is the performance of value stocks relative to growth equities. Throughout history, value stocks have outperformed growth stocks; however, in the years after the financial crisis, this trend has reversed. Growth stocks have smashed value equities since 2009 with the Russell 2000 Growth Index outperforming the Russell 2000 Value Index by nearly 140% since the end of 2009.
The performance gap has only become more pronounced over the past few years. The Russell 2000 Growth Index has outperformed its value counterpart by around 140% since the beginning of 2014. Unsurprisingly, this performance has set off a wave of speculation among the investing community that value investing's long-term advantage over growth has disappeared, and value investing is now dead.
I'm always skeptical of these declarations because there appears to be a big gap between what people think value is (and the way it is measured) and the true mark of an attractive value stock.
One of the most prominent misconceptions about value investing is the idea that you have to buy super cheap stocks. This may have been true 100 years ago, when Benjamin Graham first started investing, but the markets are not the same today as they were back in 1990.
Back then, any investor who wanted to know the financial situation of a company had to go and travel to get its annual report. Today, this financial information is available at the click of a button online, and there are thousands of free and straightforward stock screeners out there to help investors find cheap stocks.
Harder than it used to be
This dissemination of information means it is harder to get an advantage over the rest of the market. Not only are there tens of thousands of intelligent people on Wall Street trying to find undervalued stocks, but there are hundreds of thousands of other value investors around the world all looking for diamonds in the haystack. With so many people chasing so few opportunities, if a stock looks cheap today, it's probably because it deserves to be.
For example, the average price-earnings ratio of stocks in the Russell 2000 Value Index is 14.9, and the average price to book ratio is 1.4. These companies are producing an average return on equity of 7.8%. These are not dirt cheap companies; they just looked to be expensive, inefficient companies.
So, the Russell 2000 Value Index is full of expensive, inefficient companies while Russell 2000 Growth Index has an average price-earnings ratio of 23, but earnings on average are growing twice as fast and return on equity is nearly 10% on average. In other words, these companies might look expensive for value investors, but they are growing much faster and have much more attractive fundamentals.
Patience is probably the most important quality for a value investor and today, plenty of patience is required. The 10-year bull market, coupled with technological advances over the past decade, means that the number of truly attractive value opportunities available on the market today is very slim.
Time is a key advantage
Finding companies that are both of high quality and trading at a discount valuation is virtually impossible, but for most investors, sitting on their hands and doing nothing is just too hard.
Chasing stocks that look cheap relative to the rest of the market or just look cheap period, isn't value investing. True value investing should be defined as finding stocks that are trading at a deep discount to intrinsic value, not finding stocks that look cheap relative to the rest of the market.
Today most companies look cheap because they are.
The only way we are going to get an advantage as value investors is to wait until the perfect opportunity arrives before diving in -- that's the advantage value investors have always had, and will always have over the rest of the market; they are prepared to wait.
Disclosure: The author owns no share mentioned.
Read more here:Â
Revisiting The Superinvestors of Graham-and-DoddsvilleÂ
Compounding Should Be at the Heart of All Investment StrategiesÂ
John Bogle's Greatest Lesson for InvestorsÂ
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