Fixing Value Investing Underperformance

“Over time, we hope to outpace this yardstick [the S&P 500]. Otherwise, why do our investors need us?” --- Warren E. Buffett’s Owner’s Manual

Value stocks have significantly underperformed their relevant benchmarks over the last decade. Here, I highlight this major problem in investing today and set the stage for unveiling a fundamentally-driven solution which will be expanded in subsequent articles. To illustrate the magnitude of underperformance, the chart below shows that the S&P 500 Value Index not only persistently delivered Lower Returns than the S&P 500 Index over the last 3 years, 5 years, and 10 years, but has done so with Higher Risk. 

The table below further shows that, over the last year, Value continued its poor performance.

Active value managers have performed worse than the passive index funds as shown above. The persistent underperformance of value-based investing should be of concern to:

• Asset managers who are paid to deliver better outcomes than the benchmarks,
• Pension funds, with billions of dollars invested in value mandates, that are struggling to generate the required rate of return necessary to meet their pension obligations,
• Over 75% of investors who now assume the risk of investing for their retirement, and
• Financial advisors who are fiduciaries.

Major investors, like Warren Buffett of Berkshire Hathaway have used the essence of “value investing” to manage their portfolios successfully. But many fund managers have potentially misunderstood the concept of fundamental analysis to properly classify value-based stocks.

The prevailing method of value investing that gave rise to its underperformance is implemented, for the most part, using three variables: the ratios of book value, earnings, and sales to price. This method is obviously not working. My research has led to the development of an alternative methodology for fundamental classification that is based solely upon GAAP financial statements.

According to the Securities and Exchange Commission (SEC), the best way for investors to protect their investments in the securities market is to research companies’ financial statements and ask the right questions. The Financial Accounting Standard Board (FASB) shares the SEC’s view. The FASB sets standards by which Generally Accepted Accounting Principles (GAAP) financials statements are prepared. Publicly disclosed GAAP financial statements provide objective information that is critical to making informed decisions, including whether to buy, sell, or hold a company’s stock.

I have demonstrated through years of empirical research that financial statements information (10Ks, 10Qs, and 8Ks) as the sole input to stock selection models, leads to the creation of portfolios that persistently outperform their peers and the relevant benchmarks. Financial statement data is foundational and can serve as input to asset owners and asset managers’ investment processes (regardless of their investment styles), giving them the insight and power to develop and deliver persistent alpha-generating strategies by reducing risk.

I look forward to using this space to share my research and solutions to Value Investing’s seemingly intractable problem of persistent Lower Returns and Higher Risk and I invite you to visit Valspresso’s site www.GAAPFundamentals.com to learn more and sign up to receive my articles as they are published.