Value investing has proven to be one of the most successful investment strategies over the long run. By focusing on buying undervalued stocks trading below their intrinsic value, value investors like Warren Buffett have consistently beaten the market. However, in order to reap the full benefits of value investing, investors need to have a long-term mindset. Short-term underperformance is common, but over long periods of 5-10 years or more, value investing tends to outperform growth strategies. This article will make the case for long-term value investing and explain why it works.
Value investing requires patience to allow the strategy to work
One of the key tenets of value investing is having a long investment horizon. Legendary investor Warren Buffett has said his favorite holding period is ‘forever.’ Short-term underperformance is very common in value investing. A stock can remain undervalued or even become more undervalued in the short run. But over long periods of time, fundamentals drive returns. As corporate earnings grow and valuations revert to the mean, value stocks tend to outperform. Investors must have the patience and discipline to hold through periods of underperformance. Selling during short-term price declines can lock in losses and prevent investors from realizing the full upside potential.
The historical track record proves long-term outperformance
Numerous academic studies have shown value stocks outperform growth stocks over long horizons. For example, a 1992 study by Fama and French found that between 1963 and 1990, value stocks returned on average 19.6% annually compared to just 9.9% for growth stocks – nearly a 10% outperformance. In 2000, Lakonishok, Shleifer and Vishny updated the study and found similar excess returns for value investing across 17 countries. This outperformance has continued. Recent Vanguard research shows that between 2000 and 2020, value stocks returned 6.1% vs. 5.2% for growth. While short periods of growth outperformance happen, value investing has beaten growth over decades. History shows long-term investors are ultimately rewarded.
Market psychology contributes to value’s long-term edge
There are important behavioral reasons why value investing tends to outperform over longer periods. Growth stocks tend to have great stories that investors extrapolate into the future. This naturally leads to overly optimistic assumptions and overvaluation. Value stocks, on the other hand, are shunned and neglected. Their low prices often reflect temporary problems or irrational pessimism, not long-term fundamentals. But because most investors follow trends and prefer exciting growth stocks, these mispricings can persist for some time. Yet ultimately, fundamentals like earnings and cash flows win out. As Warren Buffett famously said, ‘Price is what you pay, value is what you get.’ The long-term orientaton of value investing allows time for the upside potential to be realized.
A margin of safety provides downside protection over time
Central to value investing is the concept of ‘margin of safety’ – only buying at a significant discount to conservative estimates of intrinsic value. This provides a cushion against being wrong and losing money. Value investors want to minimize downside before considering upside potential. Though the upside may take years to be realized, the margin of safety helps avoid large losses even if the investment thesis doesn’t play out as expected. Upside stems from sound business fundamentals, not relying on greater fools in an overheated market. As Warren Buffett said, ‘Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.’ While not losing money does not guarantee making money, it protects capital for the long run.
Value investing powered the success of investors like Warren Buffett. But fully benefiting requires patience and a long-term mindset. Periods of underperformance are common as mispricings can persist. But ultimately, corporate fundamentals drive returns over 5-10 years or more. Numerous studies show value stocks have outperformed growth stocks over decades across global markets. For investors with discipline and a margin of safety, value investing remains a proven strategy.