Value investing aims to identify and invest in undervalued stocks that have the potential to appreciate over time. While the strategy has proven successful for legendary investors like Warren Buffett, average investors often struggle to consistently apply value principles in a disciplined manner. This is where systematic value investing comes in – it provides a rules-based, quantitative approach to finding bargain stocks using factors like low P/E, P/B ratios and high dividend yields. When executed properly, systematic value strategies have generated meaningful alpha over long time periods. However, recent underperformance has led some to question whether value is dead. Examining the empirical evidence and refinements made over the years provides reasons for optimism about the future of disciplined value investing.
Strict rules and algorithms help mitigate behavioral biases that trip up investors
Many studies have shown that investors frequently fall victim to behavioral biases like herding, loss aversion and recency bias. These emotional pitfalls lead them to abandon rational value principles and instead chase past performance. Systematic value investing implements valuation screens and stock selection rules programmatically, taking out the possibility of human emotion impacting decision making. This structured approach prevents investors from making rash moves in the face of underperformance and forces them to stick to their process.
Diversification and risk management are inherent in quantitative strategies
Value stocks, especially those in distress, tend to be more volatile. But a quantitative value approach allows constructing a diversified portfolio spanning various sectors and market caps in a disciplined manner. Systematic strategies can also implement portfolio constraints and risk guidelines to manage concentration risks. This avoids excessive exposure to stocks with uncertain fundamentals that could lead to permanent loss of capital if bought individually.
Sophisticated data analysis refines definitions of value over time
Early value screens relied on simple price-to-book and price-to-earnings ratios. But ongoing research has led to enhancements like accounting for intangible assets, using composite valuation measures and distinguishing between cheap stocks versus improving fundamentals. For instance, Greenblatt’s magic formula incorporates concepts like return on capital in addition to traditional value metrics. Systematic investing allows quickly testing and implementing these refined techniques at scale to adapt traditional value approaches to changing market conditions.
Systematic value investing strategies that use quantitative models and rules have key advantages in consistently executing a disciplined approach over long horizons. Mechanical stock selection avoids behavioral pitfalls while ongoing research into evolving datasets and factors seeks to enhance the premium from buying undervalued stocks.