Thursday, 9 October 2014

Why Value Investing works. Buying cheaply works.


Markets are not Efficient
All you should worry about since you aren’t going to be able to outguess the market is minimizing transaction costs, and allocating assets that creates an appropriate risk profile. What I think you ought to know about that is two things.

  • The first is that there is overwhelming statistical evidence that markets are not efficient. In all countries and all periods of time since the early 20th century, that there are variables that can be reliably used to outperform the market and that clearly contradicts the premise that nobody can outperform the market. 
  • There is a sense in which absolutely and fundamentally markets are efficient and it is this—that when we buy as night follows the day someone else is selling that stock thinking it is going down--and one of you is always wrong. (Don’t play the patsy!)

Why Are You on the Right Side of the Trade?
Another way of saying that is not everybody can outperform the market. The famous humorist called Garrison Keiller talks about a fictional town called Lake Woebegone. In Lake Woebegone all the women are beautiful, all the men are tall and all the children are above average. In this game all the children are average on average which means half of them underperforms the market. So when you start to think about investing, you must be able to answer the question:

  • Why are you able to beon the right side of the particular trade? 
  • Why are you the one who is right, and the person who is trading with you is wrong? That is the most fundamental aspect of Investing. 
  • Where and what is your investing edge? 
  • What puts you on the right side of the trade?

Buying Cheaply Works
When we talk about value investing there is a lot of evidence that value investors have been on the
right side of the trade. 

  • The statistical studies that run against or contradict market efficiency almost all of them show that cheap portfolios—low market-to-book, low price-to-book—outperform the markets by significant amounts in all periods in all countries—that is a statistical, historical basis for believing that this is one of the approaches where people are predominantly on the right side of the trade.  And, of course, someone else has to be on the wrong side of the trade.
  • Those studies were first done in the early 1930s; they were done again in the early 1950s. And the ones done in the 1990s got all the attention because the academics caught on. There is statistical evidence that the value approaches—buy cheap securities—have historically outperformed the market.  Buying Cheap works.

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