Value Investing Is A Long-Term Strategy and Should Be Judged Accordingly
Almost by definition, value investing rarely performs well in the short run. This is especially true when you are in a strong bull market like we’ve been in since March 2009. Most companies as represented by the S&P 500 are currently trading at fundamental multiples that are significantly above historical norms. Below is a 20-year historical earnings and price correlated FAST Graph of the S&P 500. There are two valuation reference lines on the graph.
The dark blue valuation reference line represents a normal P/E ratio of 18.12. The orange valuation reference line represents a fair value P/E ratio of 15. As you can see, for most of that timeframe market prices traded between those valuation references. However, note the two outliers calendar year 2000 to the beginning of 2002 and calendar years 2017 to current. Clearly, current valuations are high. Not necessarily crazily high as some people believe, but undoubtedly higher than historical norms nevertheless.
S&P 500 Twenty-Year Valuation Levels
Consistent with what I have shown above, many if not most of the most recognized and popular stocks are also currently trading at extremely high valuations relative to their norms or their fundamentals. Famous Dow Jones Industrial Average stocks such as Apple, Walt Disney, Procter & Gamble, Nike, Visa, Microsoft, McDonald’s, Coca-Cola and United Technologies represent just a few good examples of great companies trading at abnormally high valuations. In addition to simply being great companies with superb historical operating results to include superior records of dividend growth, these are also some of the most popular stocks on the planet.
However, as legendary investor Warren Buffett once stated “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.” I believe that Warren is trying to tell us that popular stocks are likely to be overvalued whereas unpopular stocks will be where the best bargains can be found.
On the other hand, and what I consider the dark side of being a value investor, is that it often takes a long time before you eventually reap your rewards. Consequently, being a value investor also means being a patient investor. Or perhaps more appropriately stated, being a value investor also implies having a long-term mindset.
This speaks to why Warren Buffett also said “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.” Stated more directly, value investing rarely produces instantaneous or short-term results, because value investing usually also implies investing in unpopular stocks. This unpopularity is often why they have become valuable (bargains).
Moreover, and from a more practical point of view, we must also acknowledge that value stocks are typically inexpensive for good reasons. This is especially true in a major bull market run like we have been experiencing since 2008. Therefore, the trick is to determine whether the related issues are temporary or more permanent in nature. Additionally, we need to ascertain whether the discounted stock price is justified or perhaps an overreaction. These judgments can help us determine the level of risk we are facing and if we are being adequately compensated for taking it by the low valuations or not.
On the other hand, in the long run value stocks often dramatically outperform and very often do so by taking on significantly less risk than other strategies such as momentum, or in many cases even growth. This is attributed to the fact that the risk is being mitigated by low valuation (price). As a result, I believe the key benefit of value investing is the valuation risk mitigation element. Experience has taught me that stocks that are properly valued, or better yet, undervalued, are more defensive in a bad market than overvalued stocks are. I will be elaborating more on this in the video later.