The success and failure of value investing can be boiled down into two components:
- Buy Cheap Stuff
- Avoid Behavioral Bias
Buy Cheap StuffBen Graham outlined the first point in his 1976 article published in Medical Economics:
Interviewer Question: Okay. SO, as of today, your formula says to consider only stocks with a P-E of seven or less. Is that all there is to it? Graham Answer: ....you should select a portfolio of stocks that not only meet the P-E requirements but also are in companies with a satisfactory financial position.Essentially, value investing comes down to buying cheap stocks that aren't going bankrupt anytime soon. That is pretty simple.
Avoid Behavioral BiasValue investing might be simple, but it is not easy, for the following reason--investor psychology. Graham outlines the second point in the following quote:
"The investor's chief problem - and even his worst enemy - is likely to be himself."
--Ben Graham, The Intelligent Investor
A Possible Solution?So we know that buying cheap, high quality stuff has worked historically. We also know that the reason investors fail to be successful value investors is due to poor behavior. We've proposed a solution to being a successful value investor in our piece on the "Quantitative Value Philosophy." Can the quantitative value philosophy, which systematically looks for cheap, high quality firms, but without the behavioral baggage, be successful? Unclear, because success or failure depends entirely on the investor. Our hope is that investors--empowered through education--can make better decisions in the future. And in the spirit of education, we recap some of the classic research pieces on simple value-investing approaches.
Recapping the Academic Research
P/E Recap Collections
- Quantitative Value Research: Low P/E
- Quantitative Value Research: Long-term P/E Ratio
- Quantitative Value Research: Weighted P/E Bracket
- Quantitative Value Research: E/P or Size Effect?
- Do Cash-Adjusted P/E Ratios Work? (2012)
Shiller P/E ("CAPE")
- How does the Shiller P/E ("CAPE") perform as a stock selection tool? (2013)
- The Shiller P/E Ratio (2011)