Abstract
Abstract Value investing refers to the buying or selling of stocks on the basis of a perceived gap between their current market price and their fundamental value – commonly defined as the present value of the expected future payoffs to shareholders. This style of investing is predicated upon two observations about publicly listed companies and their stock prices: (1) a share of stock is merely a fractional claim on the futures cash flows of an operating business, and that claim is the basis of its long-run value; (2) over shorter horizons, prices can deviate substantially from the long-run value of the stock. Value investors buy stocks that appear to be cheap relative to their intrinsic value and sell (even sell short) stocks that seem expensive.
Highlights
Value investing refers to the buying or selling of stocks on the basis of a perceived gap between their current market price and their fundamental value – commonly defined as the present value of the expected future payoffs to shareholders. This style of investing is predicated upon two observations about publicly listed companies and their stock prices: (1) a share of stock is merely a fractional claim on the futures cash flows of an operating business, and that claim is the basis of its long-run value; (2) over shorter horizons, prices can deviate substantially from the long-run value of the stock
As Lee et al (1991) and many other studies show, it is not unusual to observe closed-end funds trading at discounts of up to -30 to -40% relative to their net asset value (NAV) or premiums of +10 to 15% or more
Two stylised facts emerge from the preceding literature survey: (1) smart value investing, which incorporates both cheapness and quality, is associated with higher future stock returns and (2) these strategies are being actively exploited by professional investors
Summary
Value investing refers to the buying or selling of stocks on the basis of a perceived gap between their current market price and their fundamental value – commonly defined as the present value of the expected future payoffs to shareholders. One of the most remarkable regularities in the empirical asset pricing literature has been the fact that value investing is consistently associated with positive abnormal returns Both empirical academic studies and the evidence from a host of professional asset managers seem to confirm this. We see time and again that firms trading at lower pricing multiples, with stronger balance sheets, more sustainable cash flows, higher profitability, lower volatility, lower Beta, and lower distress risk earn higher, not lower, future stock returns This pattern in cross-sectional returns, which I refer to collectively as the “value effect”, was first recognised by famed Columbia University professor Benjamin Graham and documented as early as 1934. After we have established the plausibility that prices can and do diverge from value will I turn to the practical business of measuring firm value and exploiting apparent market mispricings
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