The Perversion Afflicting Value Investors

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Successful investment management can be Impaired by perverse incentives, which are what now plagues value funds.

When researching potential investments, we often must choose between math and facts versus irrational human behavior. For instance, the rise of passive investment strategies has many investors favoring “value” stocks not on valuations or earnings trends but on self-serving Wall Street classifications. As a result, larger companies that meet vague categorizations attract more passive dollars. This makes them even more prominent and value-like, and further inflates their valuations.

For investors willing to do some work, this circular pattern leaves excellent value stocks in the wake of the behemoth passive value investment liner.

Benjamin Graham

In the words of value investing legend Benjamin Graham:

The true investor will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

As Graham stated, value investing is not a popularity contest. It involves picking stocks that trade at cheap valuations and pay dividends. Despite his wisdom, value investing has morphed into buying the largest companies simply because they are labeled "value" by the banks and brokers that are heavily incentivized to grow their asset base on which they earn fees.

To help appreciate the warped investment world, I present two stocks.