Value Investing is Dead

Ask anyone. Nobody does that fuddy-duddy crap anymore. It’s boring as hell and doesn’t work.

Barron’s has written about the death of value investing… so has the Wall Street Journal. Even some of the value guys think that value doesn’t work anymore.

Well, allow me to dispute all of this with a resounding cry of “bullshit!”

First, the methodology for making this determination is ridiculous. The Russell Growth Index has indeed resounded and thrashed the Russell Value Index over the last decade. But that doesn’t mean anything.

The Russell Value Index is simply the 50% of the Russell 2000 ranked by price-to-book value. It tracks 1,000 stocks without an ounce of consideration given to quality and safety. The index has no relation whatsoever to value investing.

Value investing works because it’s not just a yardstick methodology that ranks the market by price-to-book value (a ratio that compares a company’s market value to the net assets of a company).

While investors use price-to-book to measure companies, true value investors only buy those that have a margin of safety. That’s defined as the ability of the company to survive. If company shares were to be liquidated tomorrow, they can do so at a profit based on the current price. And it’s what protects them from large losses in declining markets.

While I confess to loving a good liquidation arbitrage situation, they don’t happen that often. Looking for undervalued stocks that can recover and grow again with little to no risk of financial distress or declines in book value is the heart of pure value investing.

Value investing is how Warren Buffett and Charlie Munger got rich in the first place. It is the underlying principle that lies at the ear of the fortunes of Carl Icahn, Bill Ackerman, Seth Klarman, and a host of other billionaire investors.

“Ah-Ha,” goes up the cry. Warren and Charlie don’t use value investing anymore. They buy and hold good businesses.

That’s true. However, it does not have one damn thing to do with value investing working or not working. It has to do with being too damn big for value investing to be a reasonable endeavor for them.

One does note that Warren and Charlie still do engage in a form of value-oriented investing, and almost no one realizes they do so. Warren and Charlie are buyers of good companies during a crash. But that’s a story for another day.

Value investing is not dead. It just simply doesn’t scale.

If you want to manage hundreds of millions or even billions of dollars, it will be hard to find enough old school value ideas to fill up your portfolio. If you are looking to be a superstar fund manager, value investing probably won’t work for you.

Let’s look at the purest form of asset-based value investing…

Ben Graham invented this strategy. And it’s how Warren Buffett and other legendary investors like Walter Schloss and Tweedy Browne made themselves extraordinarily wealthy. It is the simple idea of buying stocks for less than their liquidation value. The trick, however, is not to buy stocks in all of the companies trading below their liquidation value… but just those whose financial statements indicate that these overlooked companies will survive and eventually recover.

There are only 40 of these companies around at any given time. And as the market moves higher, that number will get only smaller and smaller. Right now, there are only about 15. The market cap of companies that make the “liquidation value cut” tend to be pretty small. They are rarely able to suddenly use their capital, put millions of dollars to work, and get rich collecting fees.

Those of us looking to make a ton of money and build our net worth don’t have that problem. We can buy smaller companies easily.

Using a simple strategy of buying companies that trade for less than their liquidation value and eventually selling them when they are fairly priced has yielded me annual returns of over 20% for the past 20 years.

Value investing is not dead.

In its purest form it is not only for the already rich. It’s the exclusive tool for those trying to get rich themselves.