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The Problems with Value Investing

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By ZENWAY - Posted on 23 January 2009

For years, value investors ridiculed Mr. Market. This year, Mr. Market got his revenge. When value investors make mistakes, they often come up with multiple explanations attributable to sound value investing principles.They can blame the manic depressive Mr. Market. They can say the margin of safety is getting bigger and therefore it's a better buy. They congratulate themselves that they are patient focusing on the long term whereas everybody else is chasing momentum. They love to pick things from the garbage can and end up with a portfolio of real garbages.

All in all, the value investing system, in the unorganized general form discussed by the value investing community, does a poor job alerting the investor that he made a mistake. So often times, the value investor's arrogance creeps in. It's so hard for value investors to admit and recognize a mistake. It's so easy to just blame Mr. Market.

Value investors laugh at growth investing and refer to them as momentum investing or herding. However, it seems the growth investors may have better triggers to recognize mistakes and cutting losses if they practice in a systematic way. At least, growth investors may have more humility with a much needed respect for Mr. Market in most situations.

We believe value investors need a more organized system to help them recognize mistakes, instead of simply pointing to the market madness.

Value investing, practiced in "black or white" absolutes, can becomes a folly at certain times. That's why we see Warren Buffett evolved over time and moved to a certain extent towards growth investing.

Every coin has an opposite side. Any principle has the other side that needs some deep thinking.

Here are some issues with double edges in value investing:

1. Invest for the long term. But even Keynes said, in the long term, we are all dead.

2. You have to compute the value. But value itself is invisible.

3. Buy good businesses. But a bad business below net net cash could be sure bet.

4. Most value investors think of Mr. Market as manic depressive. However, we found Mr. Market smarter than many superinvestors in many situations. Just see how many self-claimed value investing experts got burned and trashed, yet they still believe they are smarter than Mr. Market. So the stupid Mr. Market can be smart at times. And he can be smart over time.

5. Don't follow anyone. But only way to learn is study and follow the right hero. It's impossible to get anything done if we don't trust anyone.

6. Ignore the short-term price volatility. But the drop in your portfolio is the reality you have to face.

7. Margin of safety. But how much margin is enough? Is the value a moving target? And often times if you don't pay up, you miss the opportunities of a life time.

In the end, there might some truth in the ancient wisdom that nothing is absolute. Too many value investors believed that certain things are absolute and they stopped thinking. In a changing world, nothing is set in the stones.

Some say "Thou shall not kill" is set in the stones. And love is the universal law. But what if someone wants to rape and kill your wife and daughter?

The world changes. Everything has pros and cons. We humbly submit that value investing has pros and cons, too. And value investors need to practice humility with their unbending "principles".

We are trying hard to get rid of our 'value investor's arrogance". By pointing out the downside of value investing, we won't make ourselves popular in the value investing circle. But we love to rethink about all our beliefs starting with blank sheet of paper.

Yes, there are a few simple yet timeless principles that can be good guiding posts. But the true master has no rules! This universal law should be true for value investors as well. The true masters like Warren Buffett make their own rules. But even they themselves make big mistakes occasionally. We all make mistakes and get fooled by the All Mighty.

Such is the puzzle of the Universe that we live in.

Last year, we did a lot better than the market averages. But we were shockingly humbled by Mr. Market. We hope we can stir a debate about the follies of us, the value investors.

Here are some obvious problems with value investing:
1. If things go wrong, blame Mr. Market. Too late to admit that the crowd can be right.
2. Value investors often buy too early falling into too many value traps.
3. Unorganized frameworks and operating systems.
4. Big crowds following a few "stars" in many value conferences.
5. Swamped by too much documents to read and fail to see what is obvious.
6. Categorically rejecting the utility of market analysis and supply and demand analysis
7. Value investors often sell out too early based on value leaving too much on the table.
8. Betting against the crowd is hard to do psychologically and sometimes financially damaging.

We are not expressing doubt about the fundamental soundness of value investing principles. We ask ourselves how can we improve our system to prevent dogmatic thinking down the road. How can we redesign a crash-proof system starting from a blank sheet of paper?

If scientists can revert and always revert to find better solutions to tough problems, can we, the value investors, revert some of our own biases and strong opinions.

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