Even in the best of times, investors are looking for strategies to beat the market. While this leads many to take unnecessary risks, one proven investment approach, value investing, may be more important than ever. So, if you are searching for a way to protect your money while still investing like Warren Buffett, then value investing is for you.
What is Value Investing?
For the uninitiated, the classic definition of value investing is this: picking stocks that trade under their current book value. To determine book value, we consider at the total value of a company’s assets, minus the total value of a company’s liabilities.
For example, General Electric has a current book value of 56.13 billion and is currently trading at a price-to-book ratio of 2.11. Compare this with a company like Amazon, which has a current price-to-book ratio of 16.91. Based on this first pass of the information, it would appear that General Electric is a better investment target than Amazon, right? Not so fast.
While this might prove to be true, there is more to value investing than just glancing at the price-to-book ratio. Intelligent investors will also consider at the business’s outlook and if it is mired in any issues that could further erode the stock’s value. Given the recent news, General Electric might not be such an attractive target – at least not at the current price.
In fact, neither General Electric nor Amazon are ideal targets for a typical value investor at this point. However, the examples serve to highlight the underlying philosophy of finding undervalued stocks with momentum, and then making a trade. This can feel like finding lightning in a bottle, but it is also a substantial reason why many advocates of value investing extoll the virtues of exchange-traded funds for the average investor.
One challenge value investors have faced in recent years is that with the market constantly pushing new highs, there are few value stocks on offer. This is why many have sought opportunities in emerging markets or even in private equity. Granted, neither of these sectors is without risk, but the frothy US market has priced many value investors out.
But this does not mean that value investors need to sit on the sidelines. In fact, MSCI USA Value Index actually outperformed the MSCI Momentum Index during last year’s sell-off. As you can see, timing is everything, even with value investing.
Why is Value Investing Poised for a Comeback?
If this year’s early August sell-off is any indication, storm clouds are gathering in the stock market. In fact, the early part of this year was all about momentum, likely due to the continued impact of tax cuts–something which most investors believe is starting to wane.
With the Federal Reserve’s recent decision to cut interest rates and rising concerns about the trade war, there is a case to be made for a potential slowdown in the broader economy. The weakness could end up hurting people in industries such as construction. A current review of the construction daily reports of industry insiders currently points to a robust pipeline of active projects for now.
However, the longer the current bull market runs, the increased likelihood that a bear market will return. This could be profitable to value investors, as the price-to-book values of scores of stocks will be repriced due to broader concerns in the market. In doing so, several buying opportunities will present themselves to savvy investors. This exact strategy is how Warren Buffett has made billions.
Keep in mind, we are unlikely to encounter a bear market at this point, however several observers can see the potential of a correction in the near-term.
What You Can Do About It
What can you do? Even with the market at or near its highs, now is the time to do your research and identify those pockets of opportunity in the broader market. In fact, this approach might help you to discover a stock which is currently being overlooked.
Beyond this, us this time to hone your models, including what your trades would look like. From there you can set in motion the sparks needed to engage in a position and when to exit based on your terms.
Why is value investing more important than ever? Simply put, the party cannot go on forever! If you want to protect your capital, then now is the time to turn to the proven strategies which have yielded returns in good times and bad–one of the most important is value investing.