Abstract
Value investing is a mix of science and art. It is one of the most traditional and familiar factor strategies among academics and practitioners. A value investor aims to buy bargains in the financial markets by focussing on understanding the underlying business behind the stock and deciding whether it is cheap, fairly valued or expensive. Benjamin Graham and Warren Buffet are among the many successful value investors and are a testimony to its success. This chapter offers an insight into rules-based value index strategies and how they are constructed. It further highlights the advantages and challenges that come with such rules-based approaches. Often, too much emphasis on low prices can mislead investors as a low price does not necessarily lead to a bargain or constitute the value characteristic in itself. It makes sense to consider attributes that can assist in understanding the financial health of companies in portfolios.
This is a preview of subscription content, log in via an institution.
Buying options
Tax calculation will be finalised at checkout
Purchases are for personal use only
Learn about institutional subscriptionsNotes
- 1.
EBITDA denotes Earnings before Interest, Taxes, Depreciation, and amortization. It is an indicator of a company’s financial performance which is essentially net income with interest, taxes, depreciation, and amortization added back to it and can be used to analyse and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. Enterprise value is calculated as the sum of market capitalisation, preferred shares and total debt less the total cash.
- 2.
“A Test of Ben Graham’s Stock Selection Criteria”, Financial Analysts Journal, 1984.
- 3.
“Popular Investment Screens for Developed Markets – Performance update”, April 2009.
- 4.
The price to book ratio for a stable growth firm can be written as a function of its Return On Equity, growth rate and cost of equity: P/B = (Return on equity − Expected growth rate)/(Return on equity − Cost of equity). Companies that are expected to earn low returns on equity will trade at low price to book ratios. In fact, if you expect the ROE < Cost of equity, the stock should trade at below book value of equity.
- 5.
The portfolio has equal long and short positions and attempts to control for a number of factors such as size, earning per share, share turnover, and industry classification.
- 6.
In this study, stocks are ranked annually using the E/P and size data.
- 7.
Generally, markets tend to place too much importance on current year earnings and the earnings trend of the market and become overly optimistic or pessimistic. This criticism goes back to Graham’s era and could apply equally today. Analysts should be focused more on the historical record of the company. Therefore, a thorough analysis of the past can provide some degree of confidence in the future. This thought process inspired the concept of earnings power. It combines a statement of actual earnings shown over a period of years with a reasonable expectation that these will be approximated in the future, unless extraordinary conditions change.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
Copyright information
© 2019 The Author(s)
About this chapter
Cite this chapter
Zaher, F. (2019). Equity Factor Investing: Value Stocks. In: Index Fund Management. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-19400-0_4
Download citation
DOI: https://doi.org/10.1007/978-3-030-19400-0_4
Published:
Publisher Name: Palgrave Macmillan, Cham
Print ISBN: 978-3-030-19399-7
Online ISBN: 978-3-030-19400-0
eBook Packages: Economics and FinanceEconomics and Finance (R0)