Michael Mauboussin recently wrote an article in The Financial Times titled – Why value investing still works in markets, in which he discusses why value investing i.e., finding large gaps between price and value, still works today as well as it ever has. The problem as he sees it is that the much popularized “value factor” is being confused with value investing. Here are some excerpts from that article:
Value investing, defined as buying or selling securities at prices different than their true value, is alive and well. You might not know that by reading headlines in the financial press or witnessing the poor returns of stocks with low multiples of price to earnings or book value per share. But here’s why you don’t need to fret about value investing.
Benjamin Graham was a professor and investor who is widely acknowledged as the father of value investing. The Intelligent Investor, arguably Graham’s best-known book, tells the story of Mr Market, a metaphorical way to explain why prices diverge from values. It also discusses the margin of safety, which impresses the importance of finding large gaps between price and value.
In recent decades, value investing has come to mean buying stocks with low valuation multiples and selling those with high multiples. However, simply buying stocks with low multiples should not be confused with value investing.
Years later, many investors and market observers still unfortunately conflate value investing with the value factor. Value investing is buying something for less than it is worth. The value factor is an ersatz [made or used as a substitute, typically an inferior one] measure of gaps between price and value. Worse, the relevance of the value factor is fading.
Fundamental value investors should focus on gaps between price and value for individual securities. The present value of future cash flows, not misleading multiples, are the source of value. As Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway, has said: “All good investing is value investing.” The value factor may be floundering, but value investing remains as relevant and useful as ever.
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