“Without being there one can’t imagine what finance was like before formal asset pricing models…investments courses were about security analysis: how to pick undervalued stocks.”
-Eugene Fama
The words “value” and “valuation” have been conflated over the years with “cheapness” in the investment community. We would like to set the record straight that cheapness, does not at all represent value or valuable. Quantitative “Value” strategies using book to price, or a composite of other similar multiples, have dominated much of the “factor-based” conversation. While in-sample research had shown the “Value Factor” to be a money-printing machine, out-of-sample, it has delivered more of a “punch in the gut” to traditional value investors.
Applied Finance has and always will be an intrinsic value advocate as Mr. Resendes pointed out in his recent op-ed, but there are no easy shortcuts. While this article caused quite a dustup on Twitter from a defensive quantitative “value” manager, we feel strongly that our work has contributed major advancements in finance and security analysis. While it is easy to identify that traditional “value” has not worked well at explaining stock returns over the past decade (or more), it is another thing to flesh out the reasons why and advance the explanatory nature of asset pricing models. Enter Quantitative Valuation.
In 1995, Applied Finance systematized security analysis and valuation to objectively and systematically value companies. Now, armed with 20 million, live, out-of-sample valuation estimates we set out to prove that our robust valuation factor and asset pricing model delivers significant alpha against commonly used asset pricing models.
Setting the Record Straight: Quantitative Value vs. Quantitative Valuation
Valuation Beta is a Quantitative Valuation approach that corrects two major issues with current pricing models and combines the rigors of systematic data and fundamental financial analysis.
1. B/P is not a representation of Valuation.
Criticism: Does not incorporate the expectation of future cash flows
2. Punishing ALL firms indiscriminately for growth is counterintuitive.
Criticism: often prevents investment in the largest most successful companies (FB, GOOG, MCD)
While we acknowledge the importance of the research done in this area before us and their contribution to the financial industry, we also must address the pitfalls of this approach to set forth a new path in explaining cross-sectional returns. By combining Applied Finance’s Intrinsic Value Factor®, Stewardship (Financial Yield®) and Leverage, we avoid these two critical flaws inherent in most Quantitative “Value” investing strategies.
We have been sharing this research with journalists, academics, and practitioners and would like to invite you review our work and join the discussion on the implications in portfolio construction and asset allocation.
Webinar: Deconstructing Value Investing: Valuation vs Cheapness Feb 24, 2021 @3:Feb 24, 2021 @3:00 PM CST
Working paper: Addressing Inadequacies of Book to Price with Intrinsic Value, Stewardship and Leverage.
Lastly, our year-end market review Backward & Forward provides our concluding thoughts on 2020 and provides some perspective on valuation levels and equity risk premiums going into 2021.
The Valuation Edge™ Newsletter Articles:
Yes Virginia, Valuation Matters. But There Are No Easy Shortcuts
Or co-founder’s spin on little Virginia O’Hanlon’s letter to confirm if Santa was real. “DEAR EDITOR: I am an investor. Experts say valuation does not matter. Please tell me the truth; does valuation matter?”
A Market-Beating Investor Explains Why Traditional Value Investing Never Really Worked
Rafael Resendes, was featured in Vicky Ge Huang’s Business Insider article, highlighting how Valuation Driven investing is more sustainable than traditional value approaches.
Looking Backward & Forward – Q4 2020 Review
Jun Wang, CFA discusses the valuation levels of the S&P 500, Equity Risk Premiums, and what to be wary of in the current market.
Market in Pictures – Issue #5
Paul Blinn has compiled an assortment of interesting charts/tweets/trends for this month’s Market in Pictures that highlight the winners and losers from 2020, Bitcoin, Tesla, precious metals, US life expectancy, and other 2020ish things.
S&P500 Expectations – Place Your Bets
After an intense run-up to end 2020, what type of growth is the market pricing-in to stocks now? Based on our recent analysis of the current S&P 500 expectations, the median company in the S&P500 is priced to grow revenue well above what they have delivered historically.
Top 5 Market Cap Concentration
The five largest stocks in the US (#AAPL, #MSFT, #AMZN, #GOOGL, #FB) dominated S&P 500 performance in 2020, returning 56.0% over the course of the year on a cap-weighted basis, while all other US stocks returned 15.0% in aggregate.