Beaten Down Value Stocks Are Less Riskier Than You Think, Here’s Why – Josef Lakonishok

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Of of the firms we follow closely here at The Acquirers Multiple is LSV Asset Management.

Josef Lakonishok is the Chief Executive Officer and Chief Investment Officer of LSV Asset Management where he heads the research and investment team and is involved in all portfolio management and research functions.

Lakonishok’s work has received many awards, including the Roger F. Murray Award for the paper “Contrarian Investment, Extrapolation, and Risk”, written with Drs. Shleifer and Vishny, and the American Association of Individual Investors Award for the article “Fundamentals and Stock Returns in Japan”, written with Drs. Louis K. C. Chan and Yasushi Hamao.

Some of the best value investing advice provided by Lakonishok can be found in the book – Investment Titans – Investment Insights from the Minds That Move Wall Street, by Jonathan Burton. In particular is his insight into why beaten down undervalued stocks are less riskier that you may think.

Here’s an excerpt from that book:

As a service to readers of this book, Josef Lakonishok, a value focused portfolio manager, has agreed to divulge the top secret of his trade. It is not for the faint of heart—but here it is nonetheless; just one word:

Patience. Patience? Lakonishok explains:

Value investors should be patient. If you demand that your investments pay off in a short time, this is not for you. To be a value investor, you need “emotional contrarianism.” You have to not mind opening the newspaper and seeing bad news.

Lakonishok is one of three principals in Chicago-based investment firm LSV Asset Management, which handles more than $6 billion in pension and endowment assets for institutional clients such as Stanford University, Sears Roebuck and Bank of America. He is also a finance professor at the University of Illinois in Champaign, Illinois, and author of several watershed research studies extolling the superiority of value over growth.

As money managers, Lakonishok and colleagues Andrei Shleifer of the University of Chicago and Harvard University’s Robert Vishny—hence the name LSV—buy shares of troubled companies that are out of favor, have below-average past performance and offer little hope for positive change. Why would anyone invest like that? Because such a classic value strategy—rooted in several important valuation methods that we will review later in this chapter—is frequently a hands-down winner.

Because a value strategy does not lend itself to immediate gains, value is often perceived as a riskier investment course over growth. But really, other than bankruptcy, how much worse can things get? Value stocks are not beautiful, so no one brags about owning them. Their shares are cheap relative to earnings, so no one expects much from them. These companies just don’t have many choices left: either they scrape along, go out of business, get acquired or maybe, just maybe, dust themselves off and get back in the game. That’s a scary proposition, to be sure, but is it blatantly riskier? Not really. These stocks are so beaten already, there isn’t much downside remaining in them. The more acute risk, Lakonishok points out, is that these distressed situations deteriorate further and the stock never goes up.

I like to think about value stocks as companies that are underappreciated by the market. They don’t have to be terrible, just on a skid. The attractiveness of value stocks is that because they’ve had a relatively poor performance, investors to some extent have given up. Yet the stocks might not be as bad as the market thinks they are. The danger is that you are actually buying dying companies. So you would like to find some catalyst; maybe just get involved with companies that are showing signs of recovery.

Buying quality companies at a cheap price is the fundamental principle of value investing that Benjamin Graham and collaborator David Dodd first espoused in their pioneering 1934 book Security Analysis. Graham refined the message for individuals in his 1949 classic The Intelligent Investor.

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