A Short History of Value Investing and its Implications

Abstract

This paper argues that what came to be called value investing was an historical accident. It arose in large part because the influential work of Graham and Dodd preceded the development of electronic spreadsheets leading them to propose short-cut estimates of value based on accounting ratios. The demise of the value premium in the last twelve years has led to doubts regarding the efficacy of this approach to value investing and an efforts to adjust the accounting ratios to make them more robust. The argument here is that this effort is misguided. Instead, it must be recognized that value investing amounts to comparing estimates of fundamental value with price and that accounting ratios, however tweaked, are not a reasonable way to estimate value – it requires a full blown DCF analysis. The paper then goes on to address some of the implications of that assertion.