stock

Quality Dimension of Value Investing: Graham to Greenblatt

Quality Dimension of Value Investing: Graham to Greenblatt

Benjamin Graham will always be remembered as the father of value investing. Today he is primarily associated with selecting stocks on the basis of valuation metrics like price-to-earnings or market-to-book ratios. But Graham never advocated just buying cheap stocks. He believed in buying undervalued firms, which means buying high quality firms cheaply.

Graham was just as concerned with the quality of a firm’s assets as he was with the price that one had to pay to purchase them. According to Graham, an equity investor should “…apply a set of standards to each [stock] purchase, to make sure that he obtains (1) a minimum of quality in the past performance and current financial position of the company, and also (2) a minimum of quantity in terms of earnings and assets per dollar of price” (Graham 1973, pp. 183). Of the seven “quality and quantity criteria” that Graham suggested a firm should meet for inclusion in an investor’s portfolio, five were directly concerned with firm quality, while only two were related to valuation.

While Graham devoted as much attention to the quality dimension of value as its price dimension, he is nevertheless primarily associated with buying firms cheaply because it is his valuation metrics that have delivered exceptional returns. Value investing is on average quite profitable, but the quality metrics Graham employed have not reliably forecast relative stock performance. The last decade has seen resurgent interest, however, in quality investing.

Quality is often viewed as an attractive alternative to traditional growth, which performed terribly during and after the dot-com bust. Its leading industry proponents include GMO’s Jeremy Grantham, whose high quality indicators of “high return, stable return, and low debt” have shaped the design of MSCI’s Quality Indices, and Joel Greenblatt, whose “Little Book that Beats the Market” has encouraged a generation of value investors to pay attention to capital productivity, measured by return on invested capital, in addition to valuations.

Novy-Marx suggests that Value metrics work better when combined with Gross Profitbaility, especially for large liquid stocks. In another paper he also analyses various valuation methods – Greenblatt’s Magic Formula, Grantham’s Quality, Ben Graham investing and Sloans accruals.

The Quality Dimension of Value Investing Robert Novy-Marx by ValueWalk.com

LEAVE A COMMENT


Saved Articles
X
TextTExtLInkTextTExtLInk

The Life and Career of Charlie Munger

Charlie is more than just Warren Buffett’s friend and Berkshire Hathaway’s Vice Chairman – Buffett has actually credited him with redefining how he looks at investing. Now you can learn from Charlie firsthand via this incredible ebook and over a dozen other famous investor studies by signing up below:

  • Learn from the best and forever change your investing perspective
  • One incredible tidbit of knowledge after another in the page-turning masterpiece of a book
  • Discover the secrets to Charlie’s success and how to apply it to your investing
Never Miss A Story!
Subscribe to ValueWalk Newsletter. We respect your privacy.

Congrats! Are you a smart person?

We have an exclusive targeted & limited time offer for being a sophisticated and loyal reader.

ValueWalkPremium is a website and newsletter on the latest industry news much of which is not in the public domain and obtained via our sources.

We also have 10 years of resources on how to use this information to better your investment process.

Sign up for  today and get our exclusive content for 40% off. This is our second biggest discount ever!!

Use coupon code VIP20 or click on the button below

Limited time offer only ENDS 2/29/2019 or after next 25 subscribers take advantage whichever comes first – please do not share this discount with others

 

0