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.

Look outside public markets for true diversification

From a post on diversifying from The Humbe Dollar, based on Harry Markowitz’s 1952 research paper on the subject.

For instance, he explained that the number of stocks you hold is far less important than the number of types of stocks you own. A portfolio of 60 stocks might appear to be diversified. But if all 60 are technology stocks, there is still quite a bit of risk. Today, this might seem like commonsense, but at the time it was a major revelation.

Markowitz ultimately won a Nobel Prize for his work, and there’s no question it was brilliant. Today, however, there’s even more you can do to manage risk in your financial life. Here are five ideas to help you think more comprehensively about diversification:

Diversify your tax rates
Diversify your investment products
Diversify your financial relationships
Diversify the timing of your purchases.
Diversify the timing of your sales.

While this post at the Humble Dollar focuses on public market investments, diversifying can be taken much further. With easier access to alternative investments, it’s easier than ever to diversify among a large number of investment products. The trick is doing so feasibly and with proper risk management.

via Five Ways to Diversify – HumbleDollar at HumbleDollar

Pros and cons of stop loss orders

A two-sided article written by Alex Foster and The White Coat Investor taking opposing views on the usage of stop loss orders.

Alex takes the pro-stop loss side, concluding:

Investing is a balance act of risks and rewards. Investors can reduce downside risks while maintaining the potential for rewards available by using a trailing stop ladder. The benefits of using a trailing stop ladder outweigh the negatives. While laddering out of a position with staggered trailing stops does not eliminate risks, it does reduce the size of losses significantly during a bear market.

On the other side, The White Coat Investor cites six reasons he doesn’t sue stop loss orders:

additional costs

additional taxes

additional complexity

stop loss orders are a form of market timing

beware of getting whipsawed

watch out for gapping

Alex includes a final rebuttal addressing each of the arguments. A big part of of the decision comes down to how active and disciplined you can be with your investing. If you truly believe in your investments for the long-term, there’s no need to bother. If you’re looking short-term and/or willing and capable of trading in-and-out on a consistent basis yet don’t want to watch the market all day, stop losses can be used effectively.

Read more at Stop Loss Orders – Pro/Con Series at The White Coat Investor.