Bargain-Hunting: Why Value Investing is a Solid Strategy

What is value investing? Let’s start with a basic definition, because the term gets widely used and misused. Value investing involves identifying assets that are intrinsically worth more than their current market price.

What does that mean? It’s a simple definition: value investing refers to identifying a bargain and paying less for something than it’s really worth. If you do that often enough, you wind up wealthier than you would be otherwise.

But behind that simple definition is a difficult process, one that many professional fund managers spend a lifetime trying to master. Warren Buffet is widely regarded as the value investor par excellence. So what should you, an ordinary investor planning for your own retirement, know and do in order to incorporate smart value investing into your own strategy?

Rodeo Drive or Marshall’s?

Compare investing to shopping. There are some people who shop for the thrill and rush that comes from scoring a high-end, name-brand fashion accessory. Sipping Veuve Clicquot in a Rodeo Drive boutique while trying on up-to-the-nanosecond-chic $1,000 shoes is that shopper’s idea of time well spent.

But another type of shopper revels in a different thrill – that of paying a deep discount off the retail price for a designer handbag she snags from under the pile of clearance items at Marshall’s.

You see where we’re going with this – it’s the latter type of mentality that translates to value investing.

You won’t find value investors waxing on about that red-hot tech stock with a 40% annual growth projection and a turbo-charged product that “can’t lose” (and whose P/E ratio is in the stratosphere). You’ll find value investors sniffing around the financial projections and business models of companies you’ve never heard of, companies buried deep in the midst of some industry value chain that supply some product or service that produces great yawns just from thinking about it.

The Value Effect

The companies that value investors target may be boring, but they make up for it by delivering strong returns over the long term.

The “Value Effect” is the idea that value stocks tend to perform their growth stock counterparts over the long term. The “value effect” has been scrutinized closely by financial practitioners and theorists for many decades now, and it is one of the few “effects” that seems to deliver on its promise more often than not.

Growth may be good in certain time periods, like the late-1990s tech bubble or the initial phase of a market recovery after a long down period (as happened for example in 2003 and 2009), but value is where you want to be in the long run. For retirement planning that is an obvious reason to make sure that value stocks are a core part of your retirement portfolio.

Types of Value Investors

There are many different types of value funds. Some value managers are contrarians – their instinct is to move into a space when the majority of other investors move out. Others are so-called “deep value” managers who look for highly distressed companies that need some kind of restructuring to get back to profitability. This type of value investing can be highly rewarding since you are getting the assets at a bargain-basement price, but there are also significant risks. Then there are “fundamentalists” – the managers who scour every nook and cranny of a company’s financial statements, grill their customers and suppliers with penetrating questions, and arrive at a fundamental value which they compare to the current market price.

As always, a little diligence goes a long way. Make sure you have the right value exposures that best relate to your own retirement goals and risk tolerance. And remember – even if you have more of a Rodeo Drive personality when it comes to shopping, channel your inner Marshall’s mentality when you put your asset allocation weightings and choices together.

Do you have more of a Rodeo Drive or a Marshall’s mentality? Tell us what you think.