Editor’s note: This article was first published in June 2013; its examples, including Bankia’s 700% one-morning rise, Inditex shares at €100 before the 2014 split, Gamesa and the Pescanova scandal, reflect that time. Gamesa later became Siemens Gamesa, which was delisted in 2023. Banco Popular, which this article suggests could be a better investment than larger banks, failed in June 2017 and was sold to Banco Santander for one euro; its shareholders lost their entire investment. This article is kept as a historical record and is not investment advice.
More and more websites and analysts are saying that value investing no longer works, and perhaps their reasons are well founded. If we explain value investing (Benjamin Graham’s investment method) quickly and simply, it basically means buying shares on the basis of fundamental analysis, at a very low price (below their intrinsic value or book value). That way we’re buying in what Benjamin Graham and Warren Buffett call the safety zone (the margin of safety), which is the difference between a stock’s intrinsic value and its market price.
Put another way, it means counting on the fact that we’re buying a beaten-down stock, in the hope that sooner or later the market will recognize its value and the price will rise. This usually happens with stocks that aren’t very popular or that the market has somewhat forgotten. At least, that’s the theory. In practice, value investing is how Warren Buffett came to increase his holding in Coca-Cola, even though Coca-Cola is far from an unpopular company, let alone one the market has forgotten.
Why do people say value investing no longer works?
To start with, the market is completely crazy, to the point that a stock whose value is €0 (Bankia) can rise 700% in a single morning. It’s also true that most companies today trade at a speculative price; in other words, the price runs ahead of the business. In P/E terms, practically every company is overvalued if that’s all we take into account. And it’s hard for individual investors to spot an undervalued company that the thousands of analysts working in the markets today have overlooked.
But I think we should interpret value investing correctly. Nowadays it’s of little use to take a company’s financial statements and annual accounts and analyze its ROI, its P/E and so on… That’s the present, and it’s what everyone knows. We’re not going to make money from what everyone knows.
When it comes to companies’ numbers, neither Graham nor Buffett has more information than other investors, but they manage to be more visionary, better at seeing what’s coming. That’s also why they take a hard look at something individual investors don’t pay much attention to: the company’s management.
In other words, if I want to invest in Gamesa, I don’t want to know how much debt the company has or how many wind turbines it has sold in recent years. To invest in Gamesa, and do it intelligently, what I need to know is how many turbines it will sell in the coming years and how much its debt will come down in the future. I don’t want to know how much Inditex has sold this year, because seen that way, the stock at €100 is expensive on fundamentals. What I want to know is how many stores it will open in the coming years and how much it can increase its revenue. Looked at like that, on those same fundamentals, Inditex could be very cheap.
So we don’t just analyze the stock or the company itself. We also analyze its competitors, the future of its market and its sector, regulations where relevant, and even politics if the company could be affected by it.
To give more examples, value investing wouldn’t have let you buy into Pescanova, despite analysts’ recommendations. And value investing says that Popular and Sabadell* could be much more profitable investments than Santander and BBVA.
*I’ve put an asterisk next to Banco Sabadell because I’ve never sat down to analyze that company.
Now, as we said in our article “Why don’t individual investors get the same returns as Buffett?“, it’s true that Buffett, because of who he is, has access to information and investment opportunities that the rest of us can’t get.
I’ve always said that technical analysis is useful for speculating, in intraday or trend trading, but if you really want to invest for the long term, fundamental analysis, value investing, is what still works. Combining the two systems at certain moments would give us the perfect investment method.
Needless to say, value investing advises holding “forever”, in undervalued companies that, as far as possible, pay good dividends.
Further reading
- 5 steps to build a dividend investing strategy
- Why individual investors always buy and sell at the worst moment
Featured image: Conrad Poirier, Public domain, via Wikimedia Commons.
