Life is about adjusting to new information and new context. It is neither easy nor simple. People keep heuristics that worked once, but do no longer. Value investing is about finding inefficiencies in the market. It is like the book and movie “Moneyball”
The gist of Moneyball is that Billy Beane, the general manager of the 2002 Oakland Athletics baseball team, has a very tight budget (28th out of 30 teams.) With the help of an Ivy League graduate, the team finds a way to compete with the rich teams, despite that budget. Using statistical analysis they find players who are worth more on the field than their salary indicates. A cheap way to win games.
They won 103 games in 2002 and made the playoffs in both 2002 and 2003 with a budget less than a third of the wealthiest teams. It can work, but not always.
Anyone can study information but you can’t succeed unless two conditions are met:
- You believe that old methods of assessing talent, scouting, coaching, in game use of players, and depth charts do not work. It may have worked once, but does no more. It takes unconditional belief that old ways are flawed. If you don’t believe intensely, the inertia from the old guard will destroy your plan.
- You must be the only one doing it. If everyone does it, the market for players will become efficient and there will be no gain from applying the data to everyday decisions.
That structure is the basis for value investing. Find situations that others either do not know about or misinterpret. Find inefficiencies.
Believers hold tight to their cherished investment ideas when challenged. The efficient market hypothesis is still rolled out to show things that are not objectively true. Like the old guard in baseball who tried to derail Beane’s new methodology. Value managers ignore the resistance and make decisions on their own ideas of value.
There is a flaw in dismissing the idea of an efficient market. Just like baseball, the market will adjust its perception of value once many adopt the new tools. When everyone knows a thing, the value it addresses will be priced into every decision. You can gain little advantage dealing in areas where everyone knows what you know. In that way the market is efficient, but like baseball it can take years to come around.
To gain advantage, you will need to rethink older ideas. Sell in May and go away, is forgotten now, but a key element in the 50s. Don’t carry inventory overnight, went away with the day traders. Dow Jones to gold ratio should be what? P/E of the S&P 500 at 20 is too high. Buy land.
They were likely all true once, but now the context is different. For example, when a 30-year bond paid 12%, the P/E of the market was much lower. Investment decisions are made based on competing investment options. Bonds at a high rate are attractive and as there is only so much money to go around, stocks get less of it and the prices fall. Understand what information means.
Meaning is where the facts and the context of the market meet your objectives. There is no guarantee, even expectation, that old configurations will ever again create the same outcomes. You will need a bigger picture and a rigorously objective approach. No data mining to support cherished beliefs.
Once you get the idea it is okay to ignore old meaning, new opportunities abound. For advisors though, there is a serious issue.
If you use newer meaning to help clients, you will be punished by regulators if it does not work out. No old method works all the time either, but “accepted practice” will come up in the lawsuit.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
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