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Value Investing

Value Investing

Value investing can be a laborious process. Properly understanding the many aspects that influence the value of a business is time-consuming, and in many cases the end result is to add one more company to the large pile of “No” decisions.

There are much quicker ways to arrive at investment decisions, one of which is to use trend-following systems. A large body of academic research has demonstrated that, historically, it has been possible to earn excess returns in a variety of markets over time by employing systematic trend-following methods (note that systematic trend following is something done by a computer employing back-tested statistical methods, not by an analyst casting their eye over a price chart).

Quite a lot of money has flowed into hedge funds employing these strategies in recent years. BarclayHedge Ltd puts the figure at more than US$100B since 2008. However, the recent results have not been good. According to Bloomberg, the largest hedge funds using these strategies have just recorded their 2nd straight year of losses; a time when equity markets have generally delivered healthy returns.

Most investment styles experience periods of underperformance, and in all likelihood these types of strategies will again prove profitable in future. For us however, the idea of properly understanding a business and buying it for less than it’s worth remains a more compelling long-term proposition.

Time to start on another Annual Report.


Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Value investing can be indeed laborious, however like all good things it is worth the effort. The “no” decisions are sometimes the more important decisions then the yes ones.

    My tips for people who want to get better at the value investing process.
    -Decide what a investment qual;ity company looks like for you and write this down somewhere so you always know. Have a tight investment philosophy.

    -Start with an initial filter of a couple of items that a company MUST have, there for any company that doesn’t have it is already in the no pile and this will likely be quite a few.

    -Learn the various business models that keep popping up. You will be surprised how often the same business model goes over multiple industires. This will help you understand how the company works and how they make money. For example, i see a similar business plan between fashion companies and casinos, firdge water filtration containers and printers/printer catridges etc.

    -Try and keep your net of investable companies to reasopnable size. it will allow you to stay constant with the information and have a better view as to what is going on then if you are trying to look out for 100 companies.

    -Look a long way back and see how the performance has changed, is it cyclical, is it seasonal, is it growing, is it volatile, is it consistent? Only looking at the last couple of years might be enough but usually they might also hide other years when the performance has been not so good. In those years, try to work out the reason behind it or any major change.

    -Really learn to understand the business and environment they operate in. Who are the players, how dominate are they, what are the strengths, weaknesses and opportunites for the company and market.

    -Go out and get real exposure to the companies and competitors if you can. Learn the art of observation and you will be surprised what you might end up finding. Not only does this help understand the company better but you might learn and have a better view of what industries and types of companies are doing well, what businesses are starting to increase their footprint etc.

    -The biggest thing of all, be patient and act on fact rather than emotion. I know it is a cliche but value investing and patience go hand in hand. There will be times where you will be sitting on cash and have nothing to invest that money into or they may be times when the market is crashing and everyone is panicking. Be patient and act on reasonable facts and information. From a buy side point of view, big market crashes can be the biggest wealth creating opportunity.

    Like thwe article states, value investing is aa quick and effortless process but it is well worth it and will also allow you to learn so much else about business that it can only help in all sorts of other areas as well.

  2. That was a thoughtful post.

    And of course, you’re right – recent underperformance is meaningless. Value underperforms at times; remember the late 90’s, when it was really different this time and value no longer worked?

    Were the funds Bloomberg was referring to equity based? Asset class trend following has done okay (no losses, albeit underperformance to stock indices), so was just wondering.

    One comment…
    “For us however, the idea of properly understanding a business and buying it for less than it’s worth remains a more compelling long-term proposition.”

    …For me, laying aside any fantasy I might have of understanding a business enough to put a $ per share value on it remains a more compelling long-term proposition. For that matter, laying aside any fantasy I might have of gazing at charts and coming up with a sensible idea remains a compelling long term proposition as well!

    Doing neither is the most compelling to me…

    I found your second paragraph very interesting, as that’s the investment philosophy I come from (not trend following per se, but the idea that there are much quicker ways to make investment decisions), and that goes for value investing also. And, just as you mention with trend following, the academic research bears that out.

    Simple models work.

    I think those who pore over charts for hours doing all sorts of (so-called) technical analysis as well as those who pore over annual reports looking for all sorts of insights or doing (so-called) fundamental analysis…are both ‘searching for certainty’. Layering the analysis up to give a feeling of confidence. But in the end, I think there’s less warrant for confidence than if the investor followed a simple, well defined and quantified model.
    Pretty much like Ben Graham advocated, for example.

  3. Please note much of the following is conjecture, certainly not ‘publishable’.
    One of the people whom I consider a good ‘academic’ publisher of papers on the stock market said in a journal ‘the mathematics of the stock market is the mathematics of lemmings’. He does use fractals, and/or chaos in his papers. As the stock market could be considered to be a ‘game’ or dynamical system with a very large number of ‘variables’ (all those that trade r invest) it seems reasonable that it is chaotic (in the Lorentz sense)
    While not in a refereed journal I presented a paper on the stock market at a conference that showed the trend following systems (of the time), could not cope with fast collapses. A more modern one of these was the GFC. These tend to be statistically ‘rare’ events, but the change is very large. While I have not seen a paper that demonstrates that volatility makes ‘trend following’ systems inaccurate (or fail) this makes sense. As the volatility is considered to be high at the moment the failure of hedge funds also seems to make sense.
    P.S a referee at the time suggested I check the volatility/predictability links.. My data and methods are now ‘out of date’ but such a test is practicable.

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