Why should I use the value investing strategy?
Week 42 2024
This week, I received several responses on my posts on X (@valuingdutchman) along the lines of: "Why should I use the value investing strategy today?" with the following arguments:
The style has been underperforming for so long
I can easily get 10% with an index
The world has changed (because of AI, software, etc.)
Why would I buy junk if I can buy good companies?
That, of course, calls for a brief response.
The performance of investment styles fluctuates constantly. No style, whether value investing, growth investing, quality investing, or momentum investing, always outperforms the others. There are periods when one style excels over the others and then shifts.
When a style lags for an extended period and other styles do well, those other styles often become too popular. If you buy something popular, you pay the price. That’s simply supply and demand, which is the most important factor in the short term (0-5 years) on the stock market. In the long term (10 years), earnings growth is the key driver.
If you buy what no one wants, you buy cheap. Just always keep an eye on the risks!
In essence, this popularity contest in itself eventually leads to a reversal of the trend. How long and how far a trend can go is unpredictable. A year ago, I thought it couldn’t go much further, yet here we are today.
The advantage is that we’re finding many interesting opportunities now.
Investing in indexes or ETFs with the expectation of easily earning 10% is a risky assumption.
The most well-known indexes, like the world index and the S&P 500, have indeed returned around 10% in recent years. Historically, however, the average is between 6% and 7%. If these indexes have returned 10% over the past decade, the returns will likely drop to 2-4% in the next decade as they correct back to the mean.
Unless the world has truly changed this time. But that’s been thought many times before, and in the end, earnings growth and dividends have always driven stock returns. Today, a large part of that future earnings growth is already priced in.
This also assumes that society will continue to allow companies to grow. After all, the concept of “degrowth” is gaining traction in both Europe and the U.S. Historically, a 6-7% return has been considered acceptable. Why would society accept more in the future?
I often hear the argument that "the world has changed." But since the Industrial Revolution, we’ve seen a long string of groundbreaking, world-changing technologies. Why would it be different this time? Faster perhaps, but different?
Don’t forget that in the stock market, it’s ultimately people’s money being invested. People with emotions like fear and greed, which often dominate the market. As long as these emotions play a role, value investing remains relevant because we benefit from the irrationality these emotions bring.
The last comment about value investing strikes a chord. Value investing is about figuring out what something is truly worth and then buying it for much less. Buying dollars for 50 or 60 cents, so to speak.
It doesn’t matter if it’s a net-net company (selling for less than its net cash position), a flawed business, or a quality company with growth prospects. What matters is that we value it open-mindedly and objectively.
This brings us back to a simple truth: if everyone knows a company is good, you won’t be able to buy it at an attractive price because everyone wants it.
That’s why the Valuing Dutchman slogan is: "Valuing Dutchman helps you see value where others don’t."
Value investing doesn’t mean buying "junk" because junk has no value. Value investors are very cautious and focus heavily on the risks. We look more at what can go wrong than at potential profits or growth. If you take care of the downside, the upside will take care of itself.
Articles and updates this week
Bellway released its preliminary figures for the financial year ending on July 31.
Read our update: What to do with Bellway after a 44% increase
On Tuesday, the article "7 Investment Tips from Howard Marks" was published.