What does "Value investing" mean? How is it different from traditional investing?

What is 'Value Investing'

The strategy of selecting stocks that trade for less than their intrinsic values. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.

Typically, value investors select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields.

BREAKING DOWN 'Value Investing'

The big problem for value investing is estimating intrinsic value. Remember, there is no "correct" intrinsic value. Two investors can be given the exact same information and place a different value on a company. For this reason, another central concept to value investing is that of "margin of safety". This just means that you buy at a big enough discount to allow some room for error in your estimation of value.

Also keep in mind that the very definition of value investing is subjective. Some value investors only look at present assets/earnings and don't place any value on future growth. Other value investors base strategies completely around the estimation of future growth and cash flows. Despite the different methodologies, it all comes back to trying to buy something for less than it is worth.

Traditional Investing

Typical retirement wisdom advises saving and investing early and regularly. Specifically, younger workers are advised to jump into the stock market wholeheartedly and tread lightly in the more conservative bond market. The rationale for this typical investing strategy, called a “glide path,” is that stocks are riskier but reward investors with higher returns over the long haul.

Bonds are less volatile but have lower returns (except during the first decade of this century when bond market returns outpaced those of stocks). Thus, if a-year-old experiences a percent drop in her stock mutual funds, she has years or more until retirement with ample time to recoup the losses. This historical “glide path” recommendation suggests that as the worker ages and approaches retirement, she should change her investment portfolio allocation to hold a larger percentage of bond investments and less in the stock category.

Target-date retirement mutual funds abound for investors who want an easy approach to this well-preached and practiced investment approach. These funds shift their asset class percentages as the investor ages. Target-date funds employ the “more stocks when younger and more bonds when older” approach, and the investor aligns her retirement year with the target date of the fund.

Sounds great, right? If you are years old today and expect to retire in years, plow your retirement contributions into one of the many mutual fund companies’ target date funds.

This fund would likely invest a greater percent in stocks in with a smaller percentage of the total in bond mutual funds, gradually reversing the allocation between stock and bond investments until you hit retirement age at in years.

Intuitively, it makes complete sense. As a-year-old, I don’t want as much money in volatile stocks as I do in conservative bonds. What if the stock market drops percent one year and I only have a few years to make up that loss? Whereas at, I’d have a much longer time horizon within which to make up a large stock market decline.

Reverse glide path retirement. Rob Arnott of Research Affiliates did some rigorous research testing the typical glide path approach of more stock investments when you are younger and tapering as you age, ending at retirement with more bonds than stocks. He compared the typical glide path with the reverse: holding more bonds when young and reversing so that upon retirement, the stock portion of the investor’s portfolio is greater than the bond percentage. This reverse approach tested the success of a different idea: At the end of your working life, you might actually have more assets if you start out with a larger allocation to bonds and gradually decrease the bond investments and increase stock investments as you approach retirement.

Doesn’t this approach sound destined to fail? It does not intuitively make sense. Yet, check out the results of this empirical investigation. With the caveat that no one knows what the future holds, Arnott analyzed years of stock and bond market returns from to, and looked at various discreet investing/working periods during that time frame. For example, the first worker enters the workforce and begins investing in and retires in. The last worker starts in and retires in. Using such scenarios of workers with discrete investment periods, he found that the inverse glide path gave investors more ending wealth than the typical approach. This means that historically, in spite of the higher and more volatile stock market returns, the retiree ends up with more money if she starts out with a larger allocation to bonds and systematically reduces the bond allocation and increases the stock allocation during her working life.

Criticisms of the inverse glide path asset allocation approach. Given that the investment industry is largely built on the historical approach, it’s no surprise there are critics to this inverse glide path approach to retirement investing. In an article in Financial Advisor Magazine, Folio CEO Steven Wallman reiterates the conventional wisdom that those nearing retirement want less risky investments, not more stocks.

Arnott responds to this critique by saying the data doesn’t lie. Looking at Arnott’s original research, he compared investors who contributed $1, per year during each of their working years and found the traditional glide path investor ended up with an average of $, at retirement, compared with the inverse glide path investor’s retirement year wealth of $,.

In spite of the fact that the data for this study spanned years, there is still no guarantee that the results should inform the future. In reality, most economists are predicting lower investment portfolio returns in the future. To put it simply, the future is unlikely to mirror the past.

What’s a retirement investor to do? The best approach is to save and invest with a diversified portfolio of index mutual funds. Starting early is your best weapon against insufficient funds at retirement. It’s also important to consider valuations, or the price tag of investments as compared with their historical values. If stocks are peaking in value as measured by their price-to-earnings ratio, maybe you should reduce your stock allocation a bit and vice versa. Right now, many bonds offer negative returns after inflation is factored in. Clearly, you don’t want to load up on low-yielding long-term bonds now and at present, stocks are reaching high valuations. The current market conditions leave the investor in a bit of a predicament. That is the reason to maintain a diversified portfolio, to balance out the ups and downs of individual asset classes.

In other words, take responsibility for learning a bit about investing and keeping your eye on your portfolio.

Agree with Fazlur ....... ......

Value investing: The strategy of selecting stocks that trade for less than their intrinsic values. So, the value investors make profit by buying when the price is deflated and selling the stock when the stock price rises.

 Traditional investing: This relates to investment in stock, real estate, Govt. Bond and term deposits in Banks with the expectation of capital appreciation, dividends and interest earnings. 

 The risk of value investing is more than traditional investing