Theoretical Questions Regarding Value Investing
Dear all,
In a recent panel meeting a guest speaker (L/S investor) at my university stated the questions below:
(1) How can time be an enemy for value investors?
(2) Three value investors - Ms Mary Quant, Ms Senty Mhent and Count Ability – are discussing at dinner. Ms Quant says “Value investing is a numbers game. You need to sift through a big universe to find the best buys.” Count Ability says, “I think it’s all about doing detailed forensic accounting work. You need to test the numbers.” Ms Senty Mhent says, “To me, value investing is about going against received wisdom, and having the courage to buy things everyone else hates.” Which of the three do you think is right, and why?
I am still a bit confused and unsure, can you help me?
1) As time goes to infinity, alpha goes to zero. The modern fundamental investor's interpretation of the efficient market hypothesis is that 90% of the time the market is efficient. The investor will take a position in that remaining 10% because he/she RELIES on the market to eventually become efficient. So even you believe a stock is inefficiently priced, you would never take a position in it unless you believed that one day the market will efficiently re-rate it. With this in mind, you have to ask yourself what a reasonable time frame for the re-rating is. For example, is a stock really undervalued if it takes the market (which as a collective, tends to be more right than an individual most of the time) 5 years to re-rate it? Probably not
Or it could be the much simpler answer which has to do with IRR and compounding. Basically, making 1% every single day is going to much more than 365% in a year due to the compounding effect.
2) This sounds like one of those where each option is right in their own way and you just choose whichever one resonates with you
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