What is Value Investing?

There are two main investing styles – momentum investing and value investing.  Momentum investing is investing in growth.  Finding stocks that are growing fast, therefore increasing in price rapidly, and buying them regardless of the cost.  People who are buying things like Google and Facebook are momentum investors.  They are buying what is hot, expecting it to stay hot, at least for a while.

Value investing is just the opposite.  Value investors are like the guys who listen to alternative rock and hate it when one of their favorite bands makes it to the radio.  They try to find the stocks that no one would touch with a 20-foot pole and buy them.  They are trying to find stocks that are so beat up that they can scoop them up on the cheap.   They then hold and sell then when the stock turns around and becomes in vogue again.

For the last several years, value investors have been losing out to momentum investors.  Growth funds have been on a tear, shooting up like 4th of July fireworks while value stocks have done well but lagged behind.  This is common in a bull market, however.  As people get used to getting richer, they start to chase the hot stocks since they think the big returns will repeat again and again.  They don’t want to miss the next big thing.  The trouble with momentum investing, however, is that it relies on the bigger idiot theory – that just because you overpay for a stock doesn’t mean there won’t be a bigger idiot right behind you willing to overpay even more.  The trouble is, however, that eventually you run out of idiots and you can be left holding the bag.

John Buckingham wrote a good column on value investing in the June 16th, 2014 issue of Forbes.  There he points out that while value has lagged growth lately, history has shown that value investing is the better approach.  Since 1978, the Russell 3000 Growth Index has lagged the Russell 3000 Value Index by a 10.7% to 12.4% annualized rate of return.  Looking even longer term, value stocks beat growth stocks 13.7% to 9.4% since 1926.

Don’t think that value investing is safer than growth investing, however.  When you are value investing, you’re buying stocks that have declined in price, sometimes dramatically.  You might be betting on turnarounds, but turnarounds don’t always come rapidly, if at all.  Sometimes a stock falls through the floor and stays there for years.  I was a big fan of Pacific Sunwear for years.  The teen retailer seemed impervious to downturns in the economy even when adult retailers were seeing their customers stay home.  The company misstepped, however, branching out into everything from shoes to girls wear, and suddenly they were no longer cool.  The stock fell from the mid-twenties to the $2-$4 range and stayed there ever since.

One of the stock mentioned in John Buckman’s article is one I have been holding for a little over six months, Ensco (ESV).  The company makes offshore drilling rigs, which I saw as a good way to invest in the energy market.  They have seen some cuts in the rates they can charge for their rigs,  and my position is down about 6% right now.  Still, as Mr. Buckingham points out, the stock is paying about a 6% dividend, which gives a bit of comfort while waiting for the stock to do something.  I will probably reevaluate after about a year, and either buy a few more shares or cash out.

In general I don’t go into turn-arounds.  I’ve seen to many languish for years, waiting for the changes the company is making to produce results.  I normally instead find stocks that are good values but which have shown consistent growth.  I find these are a lot more predictable.  Still, there are times when a stock gets really cheap compared to earnings and even dividend that you can’t help but bite.

What about in a 401K plan or an IRA where you are investing in funds?  Should you buy a value fund since they outperform growth historically?  Should you stick to growth since it has beat value for the last several years?  Probably the best answer is to buy both.  You will never have all of your money in the style that performs the best at any given time, but you will always have money in the winning style.  That is often good enough.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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