Factor Investing: Focus on Value

July 29, 2019    Portfolio Idea Value

I recently read “God dobbelt niet op de beurs”. The book is only available in Dutch (for now?) and I can’t give you a good English book that covers similar ground, but I can share some of the lessons I learned.

First and foremost, historically speaking, you should absolutely not invest in actively managed funds. This may be common knowledge, but it’s good to reiterate. Study after study shows that, on average, mutual funds underperform the market. If you don’t want to actively manage your portfolio yourself, your best bet is to buy an ETF that tracks an index of your choice.

Second, retail investors are very unlikely to beat the market, mostly because they don’t have a system (called “investment style” in the book). And because they don’t have a system they tend to buy and sell at the worst possible moments.

That’s what this site is all about: Finding a proper system.

Factors

The book goes on to mention that one investment style that, over longer periods, has consistently beaten the market is factor investing.

It’s an investment system that takes one specific quality of stocks and focuses on it. For instance, a typical factor that has been shown to outperform the market is “high and growing dividend”. In general, if you create a portfolio that consists of stock that pays a high dividend and has historically increased the dividend, you will outperform the market over long enough time stretches.

Other popular factors include:

  • Value: These are companies that are good companies, but for some reason, the market has underpriced them and you can buy them cheaply.
  • Momentum: If a stock price is rising, it will usually keep rising. And the other way around.
  • Small caps: Small companies tend to outperform larger companies.

Value

This month, I will focus on the “value” factor.

If you look around, there are many ways to identify value stock and you should most certainly do your own research and think about everything that is proposed.

You will encounter the following ratio’s a lot:

  • P/E or price-earnings ratio: The lower this is, the more this company is earning and the more earnings you’ll get for the same price.
  • P/B or price to book value: The book value is what value you’d get if you liquidated all the company’s assets right now. As in the previous ratio, the lower this is, the cheaper you can buy the company.

This Month’s Portfolio

With that in mind, here are the criteria for this month’s selection:

  • I’m choosing the traditional European and US markets.
  • Sort by P/E, lowest first.
  • P/B under 2.
  • A mid cap company, which means an enterprise value between 2 and 10 billion.
Symbol Name Current price Enterprise Value P/E P/B
SDLP Seadrill Partners LLC 2.25 USD 3.79B USD 0.60 0.02
VVPS.VI Volksbank Vorarlberg e. Gen. 33.00 EUR 2.51B USD 0.95 0.08
SWN Southwestern Energy Co 2.13 USD 3.53B USD 1.26 0.39
XIN Xinyuan Real Estate Co., Ltd. 4.26 USD 2.86B USD 1.26 0.16
GPOR Gulfport Energy Corp 3.47 USD 3.15B USD 1.38 0.16
CRZO Carrizo Oil & Gas, Inc. 9.63 USD 3.20B USD 1.71 0.79
DNR Denbury Resources Inc 1.08 USD 3.44B USD 1.84 0.42
IRS IRSA Inversiones y Representaciones Sociedad A 10.31 USD 6.23B USD 1.88 0.26
AR Antero Resources Corp 4.30 USD 9.30B USD 2.17 0.15
RZA Reinsurance Group of America, Incorporated 27.66 USD 6.14B USD 2.25 0.18

A backtest of this criteria is not very promising (I ran my backtest using Uncle Stock). There are some very good years, but the bad years tend to be so bad it doesn’t matter. Potentially, a good stop loss could help here?


My philosophy: If you want to invest and your goal is to try to beat the market, you need a system. You need a system that can decide for you what to buy, when to sell and not to panic when things go down. Everything starts with selecting stock. You should not just select random stock here and there based on whims or things you read. No, create a system that suites your style and follow it. These posts give you example of what such a stock selection could look like.

Unless otherwise noted, I do all my research through the Uncle Stock screener. It's a great tool to have in your belt. (note: this is an affiliate link, if you sign up, I get a commision)

Disclaimer: Don't believe anything I say or write. Always do your own research before making any investment decisions.