What do you mean by “value”?
- Value as an analytical style, i.e buying something for less than it is worth? (and, in my opinion, is what any sensible investment should look like?)
- Value as a statistical factor (Fama/French), where you buy a basket of stocks scoring low on certain measures such as Price-to-Book or Price-to-Earnings?
I am asking because there is no necessary correlation between both. A P/E of 8 is still too much for a company with low return on capital, high capital expenditure needs, no barrier to entry, unionized labor, etc (think airlines before 2010 before we had some consolidation). On the other hand, paying a P/E of 25 or above can still be a bargain if you deal with an long term compounder (someone who would have bought L’Oreal at a P/E of 80 in the 1970s would still have beaten the S&P500 by a wide margin over the next 50 years).
Similarly, what do you mean by “Graham’s criteria”?
- Ben Graham’s Net-net strategy? (those stocks are very rare lately)
- Ben Graham’s Formula for evaluating stocks? Take care that he revised the constants in his formula for each new edition of Security Analysis to adapt it to the market conditions of the time. As he died in 1976, I’d like to know how his formula would have evolved today.
- Or more generally, his qualitative principles for investing, such as “a stock is a shared ownership in a business”, the concept of Mr Market, and the Margin of Safety? (with which I fully agree)
Going forward I will define quality as “a business with high return on invested capital, with a long runway for reinvestment of profits at an attractive return on incremental capital, and honest management with an owner mindset and skilled at capital allocation.”
So, coming back to what I said at the beginning, if you consider value as a statistical factor, I have absolutely nothing to say about it, as both are likely to be completely independent. There are many people buying value ETFs (as a statistical factor) on this forum with variable degrees of results.
If on the other hand you define value as buying something for less than it is worth, then quality can vary from absolutely irrelevant to the incredibly important. It is pretty obvious that a business compounding value per share at a high rate on a long time horizon is worth a lot. So it all depends of your time horizon and your holding period:
- Within 1 year, price is the most important factor and quality matters very little. If you bought a bad business but still got a bargain, good for you. But then you need the market to react quickly (i.e, have a catalyst event to realize the true value of your investment), otherwise time runs against you. Another drawback is that because you renew your portfolio often, you need to have good ideas often as well.
- In the very long term, all your returns are driven by the return on invested capital. As long as you did not pay an absolutely extravagant price for your holding, if your business has high rates of return on a long term horizon you will still have a hell of a result. You can pay 40 times earnings for a stock compounding 20% over 30 years, and it will still be a bargain.
- For holding periods between 3 to 5 years, price and quality matter equally, and, as you would expect, the longer the holding period, the more quality matters.