“Value Investing is pain, Highness. Anyone who says differently is selling something.”
–— The Dread Pirate Roberts
“The Princess Bride” is one of my family’s favorite movies. At any point during the last decade or so one could hear someone in the Goodson household quoting any of the famous lines from it. From random shouts of “Inconceivable!” to a heavily accented, “Hello. My name is Inigo Montoya,” the lines from this charming film would fill our home with warmth, humor and much laughter. Even now whenever I hear someone end a sentence with “mean it,” I reflexively think to myself, “Anyone want a peanut?” In my opinion, it’s one of most entertaining movies of my lifetime.
The original quote from the Dread Pirate Roberts in the movie is “Life is pain, Highness. Anyone who says differently is selling something,” which is, in my view, an amazing quote worthy of a philosophy textbook. My alteration of it was inspired by a quote from a famous value investor, Jean-Marie Eveillard. He was cited in a recent Wall Street Journal article saying, “Most people aren’t cut out for value investing, because human nature shrinks from pain.” This is something I have been trying to articulate for years.
Conceptually, most people understand buying something at a discount, or when that something is on sale. Yet, when it comes to stocks, this notion is much harder to implement. Most value stocks trade below fair value exacting because they have something “wrong” with them. These “flaws” usually turn off the average person (“Why not buy something better?” they would argue), and often turn on the value investor. This is why most people loved Apple (AAPL) at $700 (“The company could do no wrong” was the consensus view), and loathed Avon Products (AVP) at $14 (ousted CEO, bribery scandals, dividend cut, etc.). As shown below, AVP has outperformed AAPL by near 60 percentage points over the last six months.
AVP was a classic value stock. But what about the pain of value investing? Let’s suppose that AVP’s share price had gone down over the last six months. Anyone holding it or recommending it would look doubly foolish. Not only did you lose money, but you lost money on a stock that was “obviously” troubled and deemed likely to disappoint. This is why the average individual investor is likely to bail on value investing at the first sign of trouble. The average person cannot tolerate the pain of owning something that looks ugly and is losing money. In some perverse way, it feels better to lose money owning Apple than in some other less quality name.
Studies have shown that value stocks have outperformed growth stocks by an average four percentage points per year since 1926. Yet, most individual investors who buy mutual funds specializing in value investing tend to do much worse than this. Why? They tend to bail on these funds whenever they underperform. Human nature is averse to pain.
My favorite value investing story comes from John Neff. In the early 1980s he began buying metal stocks – gold, silver, nickel, iron, etc. He felt that all of these stocks were incredibly cheap relative to his estimate of fair value. He continued to buy them while his fund lagged the broad market for about 3 years. Then, all of sudden, the market found favor in these names and they went up something like five-fold in a short period of time. For years he was tagged as being “wrong” on his metals call, when he was just “early,” something we often see with value investors. His long-term track record is a clear testimony of his approach to value investing.
I consider myself a value investor, and have had my fair share of feeling apart from the consensus view. For those willing to stick to the game plan and ride out the hard times, I believe value investing can be a very rewarding way to invest. Maybe value investors should adopt a new slogan, “No pain, no gain.”