REPOST: Value Investing: Why You’re Doing It Wrong

As Warren Buffet puts it, value investing’s central contention is summed up in the maxim, “Price is what you pay. Value is what you get.” Know more by reading this article on Investopedia:

Tuesday, May 9 marks the 123rd birthday of the late Benjamin Graham, who is commonly known as the “father of value investing.” How would he feel if he could survey the value investing landscape today?

He might be pleased to hear that his disciple Warren Buffett, who has hailed Graham’s 1949 book “The Intelligent Investor” as “the best book about investing ever written,” shepherded Berkshire Hathaway Inc. (BRK-A, BRK-B) to a 1,972,595% return from 1964 to 2016 (compared to the S&P 500’s 12,717%).

But Graham would also have plenty of cause for concern: according to a recent paper by U-Wen Kok, Jason Ribando and Richard Sloan, value investing is in a bad way

“Formulaic Value Investing”

In 1934 Graham and David Dodd wrote that thinking about book value – a firm’s net assets – as being the same as intrinsic value is “almost worthless as a practical matter.” To be sure, book value is one of value investors’ favorite metrics; Buffett lists Berkshires’ return in terms of book value (884,319% since 1964) right alongside its share price return. But Kok and her colleagues point out that self-described value investors increasingly content themselves with analyzing a firm’s value using book value alone or in combination with a few other narrow metrics, such as trailing earnings per share (EPS) or expected ones.

Such “formulaic value investing” tends to select firms with inflated fundamentals, the authors find, rather than underpriced shares. Value investing has “taken on a meaning we don’t think Graham and Dodd intended,” Ribando told Investopedia by phone Monday. And people are losing out on potential gains as a result.

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