A Primer for Novices: A Prelude to Our Series on the Best Value Investing Books

Inefficient Markets: The Largest Market Cap Companies Can Often be Mispriced

This paper will explain some of the basic value investing strategies. We realize there are endless newsletters promising to “let you in on the next Amazon” for a low annual fee. Kailash is not one of these newsletters and believes such claims are dubious. We believe a disciplined investment program using processes with proven historical merit is the best way to build wealth.

We strive to provide cutting-edge, thought-driven, quantamental investment analysis and tools. Our research staff has been together for over a decade and has well over 70 years of combined experience. The team includes veterans in the investment management business and a prominent academic in the field of behavioral finance. Our services strive to bring high quality quantamental tools and themes to your doorstep.

Value Investing Basics: Deep Value vs. “Berkshire Hathaway” Value Investing

We believe buying stocks for the long term is a crucial building block of wealth creation. But the stock market as a whole should be approached with caution. The market price of any one security often lacks the “margin of safety” sought by value investors.

Benjamin Graham is widely considered one of the greatest value investors ever. His book, The Intelligent Investor is clear. The stock exchanges should not be approached in a haphazard fashion! Discipline and process are crucial to building wealth safely.

The sheer number of definitions around value investing can be overwhelming. In preparing to write this piece, your author Googled “What Is Value Investing?” The results were mixed in our view.

Value investing can be as simple as buying large numbers of inexpensive firms based on a metric like price to earnings. Value investing can also involve buying a company at a deep discount to a detailed calculation of intrinsic value. Our team is familiar with these and many other methods used by value investors.

We believe in buying firms of reasonable to high quality for unjustifiably low prices. In security analysis the only thing you can control is the stock price you choose to pay. The less you pay for any given asset, the greater your margin of safety. Our forthcoming series on the best value investing books will highlight some differences between deep value investors and the quality oriented “Berkshire Hathaway method.”

The Kailash Value Factor Enhances Traditional Metrics of Value

We would suggest that if you are reading this now you may end up better off than speculators. Throwing caution to the wind, many people today are chasing story stocks higher based on tips from the internet. Value investing has never been less popular than it is today….except possibly in 1929, 1969, and 1999. Even investing in growth at a reasonable price is deeply out of of favor.

The assertion that “value investing is dead” is a common refrain in every market bubble. Today is no different. Some prominent academics have joined the fray claiming that the old ways of value investing are broken.[1]

We reviewed this paper and many like it. These papers often revolve around the price to book ratio. Made famous by Warren Buffett, Fama, French and others, price to book is often used as a proxy for value. If you use that single metric as the arbiter of “value” and “growth,” then value investing does look dismal.

Our team certainly is not out to criticize price to book as a factor. We believe that using a single metric to define a diverse set of approaches and beliefs is misleading.

Kailash has published a slew of papers demonstrating that value strategies have underperformed recently. Yet this same research shows today is following an unbelievably reliable set of historical precedents.

Value Investing & Manias, Value Investing & Manias Part II, the Death of Value Investing, and our piece on Large Cap Growth & The Nifty Fifty all make this point painfully clear! Times like these are often the best moments to embrace the common-sense discipline of value investing.

Kailash’s value factor uses an array of complementary and heavily researched variables. Our value investing tools will inevitably suffer periods of underperformance. Yet we believe they can help you avoid the pitfalls of most simple multi-factor screens. Please remember that our value investing score is only one of five modules we use in our ranking tools.

The chart below shows the compound returns using just the Kailash Value Factor vs. the venerable price to book ratio. Our value factor integrates an array of value weights. The historical result suggests a significant advantage compared to simply using price to book.

The Kailash Value Factor is Proof Positive that Value Investing is Alive and Well

The GIF below shows why our value factor outperforms price to book. Each graph shows the various attributes of stocks that are cheap based on price to book and the Kailash Value score. Our value score identifies higher quality companies than a simple price to book metric.

Kailash Value Factor Improves on P/B
Kailash Value Factor Improves on P to B

Source: Kailash Capital; Data from 4/30/1989-1/31/2021 *Kailash Valuation and P/B represented by the cheapest quintile of each respective metric

Value vs. Momentum Stocks:

In this section, we are going to touch on momentum investing briefly. In its most simple form, momentum strategies can often be the mirror image of value strategies. We believe “looking in the mirror” is a healthy way to learn.

Momentum strategies put primacy on price action. They often view a stock as a temporary holding. Value investing puts primacy on viewing your investment in a company as a stake in an actual business. You are, in fact, a fractional owner of a company when you buy a share.

Kailash has published a slew of research papers contrasting these two approaches for those interested in learning more. A quick sampling would include Value vs. Momentum, Value & Momentum – The Slow Bleed vs. The High Speed, or even our piece on a specific market anomaly which created an outlier opportunity for value investors. Both strategies have proven merit, but creating awareness around these contrasting approaches can help better clarify the concept of value investing.

We believe value and momentum investing is often erroneously conflated with value vs. growth investing. The suggestion that value and growth investing are two totally different approaches can be a misnomer. Sometimes, the best “value” firms are just mispriced “growth” companies.

One of our earliest papers, The Siren Song of Growth, uses simple charts to highlight the different payoff structures to growth and value investing. Hopefully this segregates the “value growth momentum” issue.

The next section will focus on a brief review of some of the academic research on value investing. If you would like to jump over to our investor tools, please do so. You will land in a world that brings you world-class tools that are easy to understand and use.

Academics and Value Investing:

Academics such as Basu, Lakonishok, Shleifer & Vishney, Fama and French, DeBondt & Thaler, and Bartov & Kim are probably some of the most reputable and well-known researchers on value investing. In our papers, The Persistence of Profits Parts I and Part II, Kailash replicates and validates research done by value investing pioneer Joseph Lakonishok.

Our papers demonstrate that investors extrapolate very recent findings too far forward in a manner inconsistent with real-world outcomes. Human behavior causes investors to become excessively optimistic and pessimistic around firms due to short-term issues. History shows these manic responses cause mispricing that will eventually revert to the mean. This is one of the most important mainstays that underpins why value investing works.

Our team has been reading and publishing in the academic world for decades. Our investing tools allow us to publish empirically robust research on exploiting misvaluation. Our work rests on the facts, not on forecasts.

Kailash is in the “Moneyball” business – NOT the crystal-ball business. Our investing tools, research papers, and Charts For the Curious are designed to help improve your odds based on history. People often forget that all the extravagance in Las Vegas is built on a 1%-2% advantage at the tables.

We believe staying current is critical to avoiding the pitfalls of simple one or two factor value screens. As we discussed here, the accruals anomaly provided value investors a potent ally in avoiding value traps due to earnings management.

Yet so powerful was Sloan’s signal that it no longer generates the returns it once did. Our products allow you to benefit from some of the most sophisticated and intellectually durable concepts at any given time.

For those interested in digging into the heavier empirical research behind the validity of “value investing,” please feel free to reach out to us. Our knowledgeable team can help locate and deliver material specific to your interests.

We strive to provide enterprise class tools to help investors compound wealth safely. They can be found on our website or by contacting us here. To learn about the following investment research tools:

  • Click here for our paper explaining our Stock Ranking Tools
  • Click here for our research explaining how to identify firms manipulating earnings to fool investors
  • Click here for our research on some of the pitfalls faced by investors in index funds

We appreciate any consideration and interest!

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  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
[1] Explaining the Recent Failure of Value Investing, Baruch Lev, Anup Srivastava, 2019

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

  1. Click the following to read more about Are Energy Stocks Undervalued, Intraday Mean Reversion Strategy

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

February 2, 2021 |

Categories: Quick Takes

February 2, 2021

Categories: Quick Takes

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