Most value investors will tell you how much they respect Benjamin Graham and Warren Buffett, and how they stay away from the hot stock of the moment, but this seeming uniformity covers up some very different approaches to looking for value. Part of this is that finding a true deep value stock, one that is trading at a discount to its assets, is always challenging and not always feasible, so even investors with the same starting point move in different directions.
“We have long believed that the Value premium was driven both by a combination of low beta/high quality compounding ‘patience’, and by buying distressed assets at significant discounted valuations on the premise that whilst you may lose a few along the way, the majority of problems would eventually get fixed,” write Societe General analysts Andrew Lapthorne, Georgios Oikonomou, Michael Suen.
They argue that, instead of lumping disparate strategies under the same name, value, it’s helpful to divide them into two camps: patient and brave.
Quality over time versus cheap, problematic stocks
Under this paradigm, patient value investors look for high quality stocks that will preserve capital over time and return value to shareholders through dividends and buybacks on a regular basis. The main drawback is that patient investors have to watch their portfolios underperform during a bull market, but in theory they make up for this with high returns over an entire business cycle.
Brave value investors look for companies whose valuation has dropped because of some serious, unresolved problems (if the problems aren’t actually that serious and the market is over-reacting then you’ve found a true deep value stock). The Societe General report cites BP as a stock that might have appealed to a brave value investor. When the Deepwater Horizon oil rig exploded and oil started pouring into the sea, BP plc (NYSE:BP) (LON:BP)’s stock price fell from 650p to 300p.
“The point is that while we could work out that the stock was cheap, we could not work out when the oil leak was going to be capped. There was zero causality between the lower share price and BP plc (NYSE:BP) (LON:BP)’s ability to fix the problem,” write Lapthorne, Oikonomou, and Suen. “To buy at such a discount, you had to buy while the problem was at its most acute.”
Combining patient and brave value strategies
These two value strategies each outperform the market according to the index that Societe General has constructed, but their relative performance often mirrors each other, and combining the two strategies can eliminate some of the variance that you would get from each one (strategy beta is also roughly in between each individual style).