As he was winding up his book, “The Little Book of Value Investing,” author Christopher Browne addressed some the strengths and some of the criticisms of value investing.
He began chapter 20 by observing that value investing is reasonably simple and does not require great amounts of brain power: “The average person can understand the logic of it all.”
That means buying dollars for 60 cents and then patiently waiting until someone else is willing to pay you for a dollar for it. That’s been the essential practice of most great money managers. Backing that up is his personal knowledge, based on more than 30 years in the industry, that value-driven managers enjoy long careers.
Browne pointed to managers such as Warren Buffett (Trades, Portfolio), Bill Ruane and Walter Schloss. Mutual fund managers with long successful careers included John Neff of the Windsor Fund, Jean-Marie Eveillard of SoGen Funds and Bill Nygren (Trades, Portfolio) of Oakmark Funds. He added, “We have all shared the same investment philosophy—value investing. And we aren’t going to change this far into the game.”
Value investing may have its ups and downs, but it works very well in the long term and has avoided the worst downturns. He wrote, “From time to time, you read about managers who recorded 100 percent losses in a matter of days or weeks. I’ve never seen a value manager on those lists.”
As far as the author is concerned, there are always some managers who find success without value strategies, sometimes for “fairly long periods.” They are, however, the exceptions, and most managers who have beaten the market over the long haul have been “true value adherents.”
Why, then, do so few money managers use value principles? It’s a matter of temperament, according to Browne, who backs up his opinion with the findings of the relatively new science of behavioral psychology.
There are two sides to this situation. First, he wrote, “Money management attracts some of the brightest and best educated people in the world. It does so because it is highly lucrative, and success can be measured daily at the close of the stock market. Mr. Market grades you on a daily basis rather than waiting for an annual salary review.” That’s the thrill side of the situation.
But, there’s also a take-no-risks side. Browne said, “A herd instinct dominates the money management industry. If 95 percent of the money managers buy stock A and it goes down, there are no adverse consequences.” Contrarian managers who make up the 5% minority risk being called dummies if they don’t follow everyone else.
Buffett’s experience during the 1990s comes to mind, and Browne too was criticized. For example, one of his investors asked in 1999, “How long are you going to stand around like ostriches with your heads in the sand waiting for the second coming of Elvis?” The investor who wanted to follow the crowd into tech stocks got his answer the very next year with the dot-com crash. Browne, the contrarian value investor, got the last laugh.
Being a contrarian value investor also means buying stocks in which the herd has no interest, stocks that have “warts” and are out of favor. Which makes sense because they wouldn’t be on sale if they weren’t unpopular for some reason. In addition, value stocks are “boring,” to which the author responded, “Value stocks are about as exciting as watching grass grow. But have you ever noticed just how much your grass grows in a week?”
Then there is the issue of instant gratification, which many bring to their investing activities. When stocks don’t go up right away, they get frustrated and buy something else; in the process they incur transaction fees and potentially taxes.
Overconfidence is another behavioral issue to which Browne pointed. Most individual and professional investors think they will be one of the 15% of money managers who can beat an index over the long term. This also shows up in high turnover rates (again, incurring transaction costs and perhaps taxes). He wrote that research shows investors with too much confidence trade more and earn less.
Peer pressure has an influence on professional money managers, making them anxious to keep making trades. Browne wrote, “The investment world now equates activity with intelligence. If you are a portfolio manager, you are paid to act.”
The herd likes to buy madly when markets are rising, and madly exit after the market begins heading down, so they’re often losing on both sides of the stock market cycle. Reversing that result may be a simple as taking a buy-and-hold approach.
In the 31 years between 1975 and 2005, 12 of those years saw the S&P 500 go up by more than 20% (per year). Therefore, an investor should do very well by simply being in the market, knowing that nearly 40% of the years that follow will deliver outstanding returns. That means not trying to time the market, but to stick there through good years and bad.
Thus, indexing and holding makes a good deal of sense, but, according to Browne, you still need to be careful. Even an index fund bought at too high a price can be a problem, especially if that purchase was made late in an upcycle. Indexes also can be victims of bubbles.
In his book, “The Future for Investors,” Jeremy Siegel of the Wharton School of Business argued for customized indexes. His research showed that indexes outperformed when the highest price-earnings stocks were excluded, and some smaller and mid-cap stocks were included. Browne added, “In essence, value counts.”
He concluded:
“Being a contrarian, which true value investors are, is not easy. Lots of pressures are working against you. The wild swings of momentum and growth investing tend to subject investors to more thrills, and ultimately more spills, than the value approach. Value investing is more like a long trip to a pleasant destination than a ride on a roller coaster.”
Read more here:
- Â Christopher Browne: Why Timing the Market Means Losing Out
- Â Christopher Browne: Finding Value Away From Home
- Christopher Browne: 16 Questions
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