Value Investing, a Trading Strategy?

[Wildreamz]

Hi Weijian, my intention to reopen the discussion, is not strictly about comparing the performance of this 2 strategy in the past 5 years. But simply to open up an opportunity for everyone to share their experience and learnings in the past 5 years. If views changed, or strengthened etc. With the benefit of hindsight.

[weijian]

Actually, rather than say that passive funds have "fundamentally broken the market", maybe the more appropriate word is "fundamentally changed the market"? Since passive funds are here to stay and will only get bigger over time, it will also mean that undervalued smaller cap stocks on aggregate, will be undervalued permanently AND overvalued large cap stocks on aggregate, will be overvalued permanently?

People expecting a "mean reversion" will find that mean does revert, but to a "new mean" - On aggregate, overvalued stocks will not revert to fair valuation but from extreme overvaluation to overvaluation. Undervalued stocks will not revert to fair valuation but from extreme undervaluation to undervaluation.

Greenlight Capital 1Q24 letter

Imagine you have two companies and they are both worth $1 billion on a fair value basis, but one is valued by the market at $500 million and the other one at $2 billion. When a market capitalization-weighted index fund gets $5 to invest in those two companies, it will put $4 in the $2 billion company and only $1 in the $500 million company. The overvalued stock gets 4x the new investment. As a result, it then outperforms while the undervalued company underperforms.

The problem is compounded when the new money invested in the index is the result of a redemption from an active manager trying to invest in undervalued securities. Imagine that the $5 came from a professional manager who correctly understood which stock was undervalued and which was overvalued and had deployed $4 into the undervalued stock and $1 into the overvalued stock.

When that manager is redeemed from, and the funds are reinvested in an index fund, the undervalued stock experiences $3 of net selling (a $4 sale and a $1 buy), while the overvalued stock experiences $3 of net buying (a $1 sale and a $4 buy). Rather than converging to fair value, the result is that the two stocks diverge even further from fair value.

As several trillion dollars have been redeployed in this fashion in recent years, it has fundamentally broken the market. There are significant policy, macroeconomic, capital formation and corporate governance implications of all this and many of them are negative.

David Einhorn does go on and say that he is excited about "cheap equities" as it allows the active buyer to buy cheap equities and get rewarded from share buyback and dividends. We cannot deny this but this must first come from a Mgt willing to perform such shareholder friendly moves.

https://drive.google.com/file/d/1RGPikbh...Hl1Nf/view

[weijian]

As usual, a single statistic means nothing if we don't understand the dispersion (standard deviation and distribution curve) of the population.

But I thought the different scenarios and their returns are actually indicative of comfort level and the amt of work required to achieve them:

(1) Buying expensive stocks in a downtrend:
Comfort level: Easiest to do so, because expensive stocks are either hyped up by influential people OR are well known. Always feel good to buy a "good quality" company that has become cheaper in price.
Work required: Probably a couple of videos or articles about them. Simply add a negative sign to what the Market is doing, and presto, one is a contrarian!

(2) Buying cheap stocks in a downtrend:
Comfort level: Easy for "value investors" who believes that they are more sophisticated than the avg "trend followers". Always good to buy cheaper stuff than your peers.
Work required: Hey, I know some accounting/investing 101 basics like PE/PB/ROE/ROIC etc. Simply add a negative sign to what the Market is doing, and presto, one is a contrarian!

(3) Buying expensive stocks in an uptrend:
Comfort level: Now, this starts to get hard. No one likes to think they are buying expensive things. But sometimes, good quality stuff (reflected as been expensive as Market has determined that it is probably going to be a future winner) has plenty of company.
Work required: A concrete imagination of future prospects and selecting the right price are different skill sets that aren't easy adopt at the same time.

(4) Buying cheap stocks in an uptrend:
Comfort level: Obviously this is the hardest thing to do. The cheapness is indicative of its unpopularity and the uptrend has made paying a ticket for a ride to become "more expensive" - I could have gotten it at 30% cheaper a few months ago!
Work required: Everyone tries to do turnarounds but turnarounds seldom succeed. Odds are against the investor investing in them and overcoming them is indicative of the amt of work/luck/insight required. This is where a true contrarian hopes to find themselves in.

Combining ‘value investing’ and ‘trend following’ strategies to beat market returns?

Buying expensive stocks in a downtrend: annualised real return of -5.84 per cent
Buying cheap stocks in a downtrend: annualised real return of 6.17 per cent
Buying expensive stocks in an uptrend: annualised real return of 12.68 per cent
Buying cheap stocks in an uptrend: annualised real return of 14.03 per cent

By the way, the annualised real returns for US stocks are about 7 per cent from 1928 to 2021, according to Prof Aswath Damodaran of New York University.

https://www.businesstimes.com.sg/wealth/...et-returns

[Wildreamz]

Personally.. price trend almost doesn't matter, a stock can be both cheap or expensive regardless of trend and/or trailing multiple. Example: In 2014-2016 Google trades at 28-34 trailing multiple ($350-550bil market cap). 

Google today makes about $87+bil per year (TTM) trading at about 23x trailing PE ($2T market cap), was it expensive or cheap on hindsight? Would one rather have paid $450bil (30x PE) or $2T (23x PE) market cap?

Focusing on 1-year trailing or 1-year forward multiple imho misses the big picture completely.

Intrinsic value is all about the future. 

Peace.