Legendary investor Warren Buffett is famous for value investing, the buying of companies that seem undervalued in the market.
The theory
The theory is simple. Markets overact to good and bad news, meaning that the market price might not represent the true value of the company, also known as the intrinsic value.
Value investors like Buffett use different types of financial and non-financial tools to calculate the intrinsic value of a company. When they feel that the difference between the stock market price and the intrinsic value is big enough, they then purchase shares of the company.
Although the theory is simple, the actual practice is not. It requires dedication and hours of painstaking research into company facts and figures as well as a great deal of patience.
My approach to value investing
Personally, I have long abandoned the idea of following value investing. I have a full-time job and a young family. The last thing I want to do in my free time is pore through company accounts. In my opinion this is a practice best left to professionals and also for those with more patience than myself!
However, recently I have been revisiting the idea of value investing through ETFs (Exchange Traded Funds). An ETF is a fund that tracks an index or sector and can be bought and sold like a share through most online brokers.
I have always been a fan of ETFs because they allow me to invest in multiple companies in a single fund and are usually low cost, but now I have discovered there are a few that follow a value strategy.
The ETF
I have been looking at Xtrackers MSCI World Value Factor UCITS ETF (LSE: XDEV). which tracks the MSCI World Enhanced Value Index. The index follows medium- and large-sized companies in the developed world, with the companies selected on three variables: price-to-book value, price-to-forward earnings and enterprise value-to-cash flow from operations. Companies in the index include household names like Intel, Toyota and International Business Machines (IBM). This ETF is a decent size, with over $800m in assets, and has a relatively low ongoing charge.
Performance and outlook
Though the fund has performed well over both the last 12 months and five years (up almost 30% and 40% respectively), generally the value sector has underperformed the market over the last few years.
Growth stocks have stolen the show, with technology performing incredibly strongly over that period. For comparison, the NASDAQ 100, which is a tech-heavy U.S. Index, has increased by around 250%!
However, at this moment in time, the financial press is talking about the rotation from momentum shares in sectors like technology into more value-led companies and sectors. In this case, this fund might perform very strongly over the next few years.
For my portfolio
So, can I use this ETF to replicate the value investing style of Buffett? I think the answer is yes, but only partially.
As he wrote in a 1967 Buffett Partnership letter, “The evaluation of securities and businesses for investment purposes has always involved a mixture of qualitative and quantitative factors.”
Though the fund and the index it follows does a brilliant job of looking at the financial characteristics, I can’t see how it takes into account the qualitative measures such as brand, business model and competitive advantage. For that reason, I need to do more research before investing in this ETF.
