The misunderstood idea - Value Investing

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We hear this all the time, that value is the opposite of growth, value is buying something cheap i.e stocks with low P/E, value as long-term buy and hold, or value means being conservative. Let's demystify this misunderstood idea.

If value is the opposite of growth, then you should classified everyone that puts their money in fixed deposits and bonds as value investors. Because those investments don't 'grow'. But you find that absurd if someone tells you that. Value is not the opposite end of growth, they're 2 sides of a coin. We often confuse buying something value means buying a stock that isn't 'growing', or has slow growth, therefore it is the opposite of growth stocks that grow their earnings at a high double digits rate. The definition of value just means buying things for less than what it is worth. It says nothing about the growth rate of the business. Buying a high growth stock can still be value investing if the current price is less than the present value of all future cash flow. Conversely, buying a stock that doesn't grow or has low PE doesn't necessarry mean you're a value investor. Or to make it more confusing, you heard some saying value investing doesn't apply in Malaysia because there isn't many high growth moat company. So is value investing mean growth or no growth?

There's no separation between value and growth. When you achieve value, you're achieving growth at the same time. Let's apply second level thinking. Assume all else equals, given the choice between owning a stock that can grow 20% p.a versus a stock that grow at 5%, why would anyone want to buy the 5% stock when they can own the 20% stock? Because they're conservative? That makes no sense. If an investor is conservative, it makes even more sense to own the 20% growth stock, not the 5% slow growth stock. A more valid reason is because the market has a high expectation for the 20% growth stock, therefore, any misstep by the company can lead to permanent loss of capital. The expected value is negative.

A confusion on this first part generally leads others (normally non-value investors who doesn't know what he is talking about) to classify someone as 'value investor' when he owns low P/E stocks. And conversely, classifying investors who own high P/E stocks as growth investors. But the level of P/E tells us nothing about the business, it is just what the market think it is. Low P/E means the market has lower expectation compare to high P/E stocks, it has no relation whatsoever with your strategy or approach to investing. This confusion again has people equating value as being conservative.

You hear this all the time, "He owns low P/E stocks, therefore he is a conservative investor." Conservative invoke a lot of meanings such as safe, unsexy, or taking less risk. Unsexy aside, which is subjective, I never understand why low P/E stock is safe and carry less risk. And we come to assume conservative approach means happy for a lower return; whereas aggressive means taking more risk to gain high return. I never really understand this concept either. What is active investing, if it is not to achieve compounded growth that outperform the market in the long-term? Whether you are conservative or aggressive, if you're picking stocks, your job is to outperform the market, otherwise, why waste all your time to earn market return when you can do that with index fund? That is why there's no separation between value or growth, in that both are required to beat the market in the long-term.

This confusion is brought to the next level when someone says they need high risk to get high return, or in another word, they need to be aggressive, or 'adventurous'. Whereas conservative invoke a feeling of timid, which many people want to avoid, most people prefer the opposite, being aggressive, that's more exciting and alpha. It isn't hard to see why, being in investing community where majority are male - ego, confidence play a big part trying not to be seen as timid. While personalising the market is another big investing mistakes, I'll talk about it another time. Just as most people confuse about the distinction between value and growth, people drag that confusion into the definition of conservative and aggressive.

When you're conservative, you're aggressive at the same time. It isn't an 'either or' thing. Let's go back to the meaning of value investing, that is to buy things for less than its worth. The reason an investor would do it is so he can achieve abnormal return, return that beats the market under the promise that market eventually realise the true value of the business. Understanding this turns its head against the concept of 'high risk high return'. When a stock carry high risk, it has nothing to do whether it is growing fast, high P/E or anything like that, it just means there are many outcomes that can potentially happens, and there's a chance that a negative outcome might crystalised, which create a risk of permanent loss of capital. Now, in contrast, if the outcome turns out in your favour, you make a high return. While high risk high return sounds sexy, most of the time this type of investment carry negative expected value. It is like while going casino you can get some windfall from time to time, but do it long enough, you're not going to outperform the market.

Tying all these together, it is irrelevant and a waste of time to talk about what type of investor you are, whether you're value, growth, conversative, aggressive by looking at the attribute of the stocks you own. Besides, there are many ways to make money, that's what makes a market. It is not an investor call himself as, the market doesn't know and doesn't care, rather, it is the character of the investor which he brings to the market that determine who he is, and his risk. If you're taking tips from friend and buying things you don't understand, you're gambling even if you call yourself a value investor. Same for growth investors. If you're buying for future earnings potential without considering the risk, you're still gambling. Gambling creates risk; investing manage risk. We used to hear people saying "the market is risky now, I'll stay on the sideline for now." It is as if sitting on the sideline can reduce the risk level! Risk has nothing to do with where you money is. If you carry a gambling instinct to the market, that is, no scenario planning, not looking at the downside, getting excited in the market, the risk is always high regardless of where your money is. And this comes back to the essence of value investing.



Value investing is about thinking before doing, considering possible outcomes, not extrapolating, being aware of your own biases, know what you're doing, and know what you don't know. It is about decision making. Not the feeling you like to associate yourself with in the market.

As you can see, in investing, reading half-baked idea or personal opinion (with no factual evidence) is as dangerous as the stock market itself. You need to have a strong filter to differentiate between what is true and what is closer to nonsense so you can stop reading BS. You can use Wittgenstein's Ruler "Unless you have confidence in the ruler’s reliability, if you use a ruler to measure a table, you may also be using the table to measure the ruler."

When you read a person's writing, dont just read what he writes, but use the content to measure the writer as well. Sometimes, what a person writes can tell you more about the person than the content itself. Content is like the outcome, sometimes it matter, sometimes it doesn't, you should be more interested in the process, the thoughts of the person. That will get you to the heart of the matter.

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