Value investing, a style of stock picking that dates back to
Benjamin Graham and David Dodds 1934 tome, Security
Analysis, cant be mimicked by a simple
Thats one of the findings of a revised study entitled
Facts About Formulaic Value Investing that was
published this month by the CFA Institute. The research found
that portfolio managers need to use a comprehensive set of
metrics to calculate a companys intrinsic
value, as laid out by Graham and Dodd. They then need to
add human judgment to the mix to find undervalued stocks that
will outperform so-called glamour or growth stocks over a
market cycle, a pattern of returns that academics have called
the value premium.
If you go back and read Graham and Dodd, they advise
against investing simply based on ratios such as market
price-to-book value. They only use these measures as a starting
point, Richard Sloan, a professor of accounting and
international business at the Haas School of Business at the
University of California, Berkeley, and one of the authors of
the study, said in an interview.
The revised research was published this month by the
CFA Institute Financial Analysts Journal amid the
rising popularity of value style, factor-based investments that
use a set of rules to buy and sell stocks. Sloan says
factor-based investments arent delivering outperformance,
in part because theyve been designed based on back
testing of past information.
Those back tests emphasize time periods when they
worked well, but they havent worked well since, he
said in an interview. The word value is
increasingly attached to quantitative investment funds, but
investors arent getting what they think, according to
The researchers looked at commonly used measures in value
investing that dont necessarily lead to stocks that
outperform. For example, they found the book-to-market ratio
generally identifies stocks with inflated book values that are
written down over time, and that the forward earnings-to-price
ratio often points to companies that brokerage analysts are
bullish on because of future earnings expectations. They also
analyzed the trailing earnings-to-price ratio, finding that it
systematically identified securities with temporarily high
earnings, setting the stage for losses.
They all have the same problem. In recent years, there
is no evidence of outperformance, said Sloan, adding that
theres a labeling issue when it comes to
value-style, factor-based investing today.
While Graham and Dodd identified underpriced securities
using fundamental analysis, he said formulaic
factor-based funds appeal to that, make reference to it, but
they dont deliver that.
U-Wen Kok, chief investment officer of the developed markets
team at RS Investments, and a co-author of the study, points to
fee compression in the asset management industry and advanced
technology as drivers behind the rise of factor investing. RS,
which is owned by Victory Capital Management, offers
factor-based funds, as well as those managed by humans.
This paper emphasizes the importance of not just going
with a quant screen or simple model, Kok said in an interview. You need