In its purest form, value investing involves solely buying cheap companies. Just cheap companies. Studies of valuation either use high minus low (buying the cheapest stocks and shorting the most expensive stocks) or separate stocks into deciles (10 evenly split groups) or quintiles (five evenly split groups) based on their relative valuation ratios. No consideration is given for any other characteristics.
The big challenge with a pure value strategy (or a pure momentum, a pure growth strategy, etc.) is the actual stocks designated for purchase. In the case of value, an investor will end up looking at a list of stocks so unattractive that they are unlikely to even be allowed to entry into the building where a beauty contest is being held. There will be more than enough stocks with big enough flaws and risks to cause an investor to openly question the rationality of following the strategy.
A way around this problem is to require stocks to have additional characteristics. In “Fact, Fiction and Value Investing,” Clifford Asness et al. explained how including momentum and profitability components in a value strategy increased risk-adjusted returns. Strong momentum occurs when a stock’s return is above average over a period of time (e.g., 26 weeks). Profitability, as the word implies, means a company is making money. Continue Reading »
More on AAII.com
- Five Common Traits of Success Value Screens – AAII President John Bajkowski revealed the common traits AAII’s value screens share.
- Selecting a Valuation Method to Determine a Stock’s Worth – There is more than one way to value a stock; this 2014 AAII Journal article provides guidance on which metric(s) to use.
Highlights from this month’s AAII Journal
- Leveraged ETFs: Multiplying by the Unknown – The actual returns from these funds will be less than their names would imply due to a decay in leverage over time.
- Inherited IRA Rules for Spouses, Heirs and Trusts – Inherited IRAs differ from traditional and Roth IRAs, with the rules dependent on who the beneficiary is.
AAII Sentiment Survey
Optimism declined to the very bottom of its typical historical range, while neutral sentiment stayed above 40% for the third consecutive week. More about this week’s results.
- Bullish: 28.2%, down 1.3 points
- Neutral: 42.1%, up 1.6 points
- Bearish: 29.6%, down 0.2 points
- Bullish: 38.5%
- Neutral: 31.0%
- Bearish: 30.5%Take the Sentiment Survey.
The Week Ahead
Computerized Investing editor Jaclyn McClellan will speak with our Cleveland Chapter about robo-advisers on Wednesday. If you’re not in the Cleveland metro area or otherwise cannot make the meeting, you can see Jaclyn this November at our Investor Conference.
The earnings calendar lists 71 S&P 500 member companies as being scheduled to report. Included in this group are nine Dow components: Goldman Sachs Group (GS), Johnson & Johnson (JNJ), UnitedHealth Group (UNH) and International Business Machines (IBM) on Tuesday; American Express Co. (AXP) on Wednesday; Microsoft Corp. (MSFT), Visa (V) and Travelers Companies (TRV) on Thursday; and General Electric Co. (GE) on Friday.
The week’s first economic reports will be the July Empire State Manufacturing Survey, released on Monday. Tuesday will feature June import and export prices and the July Housing Market. Wednesday will feature June housing starts and building permits. The Philadelphia Fed’s July Business Outlook Survey will be released on Thursday.
The Treasury Department will auction $13 billion of 10-year TIPS on Thursday.
Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!