Why value investing doesn’t work like it used to

Models change and strategies need to be adjusted, especially as some models are exploited. What worked for Billy Beane when he built the A’s as written about in Moneyball doesn’t work any longer because all teams are aware of the value of looking for high OBP, undervalued players.

Here’s Ben Carlson with a post When Mental Models Fail at A Wealth of Common Sense:

The old mental model for value investing was that you could easily outperform through the purchase of cheap companies. Oakmark portfolio manager and notable value investor Bill Nygren recently gave a talk at Google where he discussed the changing nature of this mental model:

I think one of the frustrations you hear with a lot of value managers today is, what I did 20 years ago isn’t working anymore. I think that’s always been the case. What worked 20 years ago very rarely still works today. Twenty years ago you could just buy low P/E, low price to book value stocks, and that was enough to be attractive. Now, you can do that for almost no fee and the computers have gotten smarter about combining low P/E, low price to book with some positive characteristics – book value growth, earnings growth. The simple, obvious stocks that look cheap generally deserve to be cheap.

When I started at Harris 30 years ago, we were one of the earliest firms to do computer screening to find ideas. Once a month, we would pay to have a universe of 1,500 stocks rank ordered by P/E ratio. As analysts, the day that output came in, we would all be crawling all over it to look at what the new low P/E stocks were. Today, any of our administrative assistants could put that screen together in a couple of minutes. Because it’s become so easy to get, it’s not valuable anymore. I think it’s probably not just investing, that’s through a lot of industries, as information becomes more easily accessible it loses its value.

He ends with a prudent remider:

But you must also have the ability to adapt to changing circumstances to avoid mistakes both big and small. I like the idea of having strong opinions, weakly held. The whole point of a mental model framework is not to be so rigid that you always do things the same way.

Being too cautious can be costly in investing

Ben Carlson on the false narrative of all-time highs resulting in a crash. There’s a lot of talk about the market being ready for a correction simply because things are going well.

Here, Carlson quotes a myth from his own book, publishedin 2013:

Of course, stocks can fall from all-time highs, but hitting an all-time high isn’t necessarily the trigger that causes them to fall. Since 1950, there have been over 1,100 all-time highs reached on the S&P 500. That’s good enough for almost 7 percent of all trading days or roughly one out of every 15 days that the market is open. Here is the breakdown by decade that shows how often the S&P 500 hits a new high level:

He then goes on to give some numbers on what’s happened since then:

Since new highs were hit in 2013 there have been 201 new ATHs in total. This year alone there have already been 13 new all-time highs on the S&P 500, the same number that was seen in the entire decade of the 2000s. It’s not even the end of January.

Stocks are already up almost 8% this year and that’s after 9 straight years of gains (with 7 of those annual returns in double-digit territory). It’s been almost 20 months since we saw a 5% correction.

A good reminder that being cautious can be costly too. Rad his post All-Time Highs, Risk & Consequences at A Welath of Common Sense.