Does Active Value Investing Pay Off?  

10 August 2017:

 Countless academic studies support the notion that over time you will substantially increase your odds of out-performing the stock market by employing a simple value investing strategy - buying stocks with relatively low price-to-earnings, price-to-book and/or price-to sales ratios. However, if value investing really works, why do so many "value investors" fail to achieve the payoffs suggested by academic studies? A recently published paper explored why active value investors underperform and offered some tips on how to improve your value investing process.

Valuable Research
Dr. Aswath Damodaran, a world-renowned valuation expert and Professor of Finance at NYU Stern School of Business, researched the depths of value investing in his April 2012 paper titled "Value Investing: Investing for Grown Ups?" In his paper, he explores the various reasons why active value investors underperform and examined what he considers the three basic types of value investors - screeners, contrarians and activists.

"Screeners" search for stocks that trade at low multiples relative to fundamentals like earnings, book value or revenues, with the belief that stocks with certain fundamental qualities will earn higher than average returns over long periods of time.
"Contrarians" look for value in the most abandoned stocks with the belief that these stocks are likely to be irrationally punished by investors and will eventually (over years, not months) reverse course.

"Activists" acquire large stakes in undervalued or poorly managed companies, and use their position as a large stakeholder to push for changes that they believe will eventually unlock shareholder value.

Although the three types of value investors mentioned in Damodaran's paper use different approaches, they often wrestle with similar challenges. A few of the common challenges that value investors face are the need for a long time horizon, employing the right amount of diversification, minimizing taxes and transaction costs, and possessing the discipline required to invest against the grain. Are these challenges, which are somewhat elementary to investing, so great, that even professional value investors cannot overcome them? According to mutual fund performance data, the answer is "yes."

The Value of Active Value Investing
To test the merits of active value investing, Damodaran collected U.S. mutual fund performance data from 2007 to 2011. He then classified the mutual funds into value, blend and growth categories, and measured their returns relative to an appropriate passively managed investment option, or index fund. The actively managed value funds were measured relative to an index fund consisting of only value stocks (low price-to-book and low price-to-earnings stocks) and the actively managed growth funds were measured relative to an index fund consisting of only growth stocks (high price-to-book and high price-to-earnings stocks). The results from this simple study were not encouraging for value fund managers or their investors.

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Source: Investopedia

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