Academic studies have shown that value investing offers superior risk adjusted returns. Investors who focus on those companies which trade at low multiples of earnings and book value have an increased chance of success over those who focus solely upon the highest growing stocks.
On the surface, this may seem counter-intuitive, but digging deeper is revealing. Many investors will look to the torrid pace of Apple's (AAPL) sales growth and stock performance to justify buying high growth stocks, but it is important to remember that AAPL is the exception not the norm. Of 6,079 large-cap stocks that trade on the NASDAQ, NYSE, or NYMEX, only 11 have been able to sustain 30% sales growth for the past five years. Also, of those 11 names, only three are ahead of the S&P 500 by over 10% year-to-date. Picking companies with high sustainable growth is very hard and even if you find the right stocks there is no guarantee of superior investment returns.
Recognizing the hurdle of selecting growth stocks, value investing appears appealing. However, buying stocks because they are cheap requires great patience and discipline.
Stocks sell for low multiples of earnings and book value for a reason. Typically the company is experiencing operational problems or focuses in an industry that is unloved. When the stock prices declines, value investors must conduct thorough research, lean against the market, and believe in their convictions.
The belief in your convictions is the most important trait to possess. Many times I have made recommendations a stock in my weekly newsletter EPIC Insights and then waited months with either the price declining or refusing to move higher. As others see portfolios grow, I am left with no movement. As frustrating as this can be, markets will eventually recognize fair value. Then the stocks which have not moved for months will rocket higher and deliver the returns I target.
An example can be seen in the recommendation of K-Swiss (KSWS). Attracted to its simple business model and strong balance sheet, on February 11 I recommended purchasing the shares when the traded at $8.70. With an $11 fair value target, the shares were trading at a 26% discount to fair value and offered an excellent opportunity.
As the price remained stagnate for a month after purchasing, the broad market raced higher. Many investors may have questioned the wisdom of allocating capital to a slow growth shoe-maker during such a dynamic rally. However, patience has been rewarded. Following an analyst upgrade, KSWS has spiked above $13 and this investment has returned 50% in two months.
Having exceeded the initial price target now is the time to sell. I do not rely on Wall Street research to dictate my investment decision and will not allow an analyst who failed to recognize KSWS's fair value when the price was much lower to sway my opinion now. Instead, I will accept what the market has given, realize my gains, and look for future opportunities.