Laton Spahr, a senior portfolio manager of the value fund over at asset management giant Oppenheimer Funds, had a quote in The Wall Street Journal last week that I've had trouble getting out of my mind.
The article tackled whether or not value investing is changing in the new world order of insanely high stock prices, which have presented a so-called "existential crisis" for the value-oriented ilk I belong to.
Mr. Spahr said, "One of the toughest things is being able to articulate what value investing is anymore."
He went on to say that older, traditional methods of valuing companies have changed, and standards must be lowered to allow for the ownership of overpriced, growth-oriented behemoths like Alphabet Inc. (Nasdaq: GOOGL) and Apple Inc. (Nasdaq: AAPL).
After careful consideration, I have arrived at the inescapable conclusion that this argument is a load of you-know-what.
The quality of traditional methods of valuing companies has not changed in the slightest. Identifying bargain stocks based on the share-price discount to the value of the assets of the company still works. So does finding bargains based on a low price relative to the free cash flow produced by the company.
I can find plenty of strong companies trading at unreasonably undervalued prices, even with the S&P 500 trading near its highest levels in history. What I can't find are enough bargain stocks to fill up a multibillion-dollar portfolio.
The concept of buying companies for less than they are worth and selling for more than they are worth lies at the heart of value investing. It has worked and always will work incredibly well for individuals looking to build a nest egg or save up for their kid's tuition.
But I find it hard to sympathize with fund managers like Mr. Spahr who need to swell the size of their funds in order to generate the massive fees that pay exorbitant bonuses so they can rent office buildings in Midtown Manhattan.
The only reason these managers are trying to expand the value-investing ethos is to create higher fees for themselves with little concern about what it means for their clients' long-term returns.
The Wall Street types like to fiddle with the idea of value investing because it has simply never worked for them. It's never been a profitable strategy for those investing enormous sums of money.
All you have to do is look at the greatest value investor in the history of the world to see the truth behind why value investing works better for regular investors like us...
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This Investor's Legacy Proves Value Investing Works for Us
I'm talking about Warren Buffett, obviously.
Now, I comment on the Coca Cola--swilling, See's Candies--munching, and sometimes misleading Oracle of Omaha a lot here. He's a brilliant and charismatic investor who's definitely done a lot of good throughout his career, but the fact that he doesn't always practice what he preaches has been a personal source of frustration for years now.
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You see, one thing that many people don't understand about Warren is that he only followed the value school when he was a young man trying to make his first million dollars. He used the methods he learned from Ben Graham - the godfather of value investing - to buy valuable companies at inexpensive prices.
Over time, though, as he amassed more and more wealth, his thought process evolved. He changed because he made so much money buying bargains that he was too rich to remain a pure value investor.
When you think about it, that's an excellent problem to have.
The same goes for fund managers working with billions of dollars in capital. If you want to be the biggest fund on the block, pure value investing is not going to work very well for you.
Thanks to indexing and other passive strategies that artificially inflate the value of many companies, the bargains are found in smaller companies not heavily owned by index funds and ETFs. It becomes a challenging task to find enough of these bargains to fill up a portfolio set to generate sufficient fees to keep your average Wall Streeters in Rolexes and Gucci's.
You and I are interested in generating massive long-term profits, not massive fees. That means, until we become billionaires, the old hat value-investing techniques still work for us.
This is one of those cases in which I tell the "old dog, new tricks" mantra to take a hike. I may be an old dog, but I see no need for the new tricks. The old ones work just fine, and they include ignoring the fads, fighting the temptation to buy the outperforming "glamorous" stocks, and buying companies at unreasonably attractive prices.
Buying small banks with strong balance sheets below the value of their assets has been wildly profitable for me over the years. These firms with bulletproof balance sheets hovering at a low multiple of the cash produced by the business have outperformed the S&P by nearly four to one since 2013.
These companies won't make for very exciting watercooler chatter, and there's very little trading activity, but the returns don't lie. It's an incredibly lucrative strategy.
The story of value evolving into something new and different suits Wall Street's purposes. Buying cheap stocks still works, but more and more it has become a game that only the little guy can play and win.
If your goal is to make the most money over time and retire rich, the value school is still the best place to enroll.
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About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of Peak Yield Investor.