Another superb piece has been published by the team at AQR Capital Management under the title “Fact, Fiction and Value Investing ". It is designed as a complement to their excellent 2014 publication “Fact, Fiction and Momentum Investing" and does exactly what it says on the tin. Sadly, most academic finance papers are so dry even a cactus couldn't grow on them but, to their credit, AQR have a style that even a lay investor could (just about) get their head around. What I most enjoy about AQR's commentary is their commitment to debunking market myths and in this case they work hard to clear the mist surrounding value investing. I think the paper holds a lot of reinforcing lessons for Stockopedia subscribers… so I'll summarise a few key findings that are of most relevance.

1. Buying 'cheap' works

Investing successfully is really quite simple... though often not easy. We've long pushed the mantra that investors should focus on buying 'good, cheap, improving' companies - a philosophy based on the long term outperformance of quality, value and momentum as factors in stock selection. AQR are probably the most vocal institutional proponents of these three factors and in their paper they reiterate that 'cheap beats expensive' loud and clear. Paraphrasing…

“The existence of the value premium is a well established empirical fact: it is evident in 87 years of US equity data, in 40 other countries and even dating back to Victorian age England... The returns of a diversified portfolio of value stocks over their more expensive counterparts are available to any who choose to pursue them."

The authors make the clear distinction between 'pure' value investing (just buying the cheapest stocks in the market according to simple price ratios) and 'normal' value investing (which aims to find the best stocks within the cheap basket). While value investing returns can be improved by weeding out all the worst stocks in the cheap basket, 'pure value investing' works just fine. “A good strategy can survive a little noise" the authors say.

Of course how should you measure 'cheap'?

2. Value is best measured by a blend of ratios

A lot of investors stick to a single preferred valuation ratio to measure 'cheapness'. For private investors, it's often the Price to Earnings ratio, but in academic circles the lion's share of the studies have…

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