What Kind of Value Investor Are You?

As value investors, it is important for us to know and recognize our various breeds. To some value investors this actually might be a new concept: there isn’t only one type of value investor. To others, this could just be an elementary review. But, in either case, it is important know that these different types do, in fact, exist. Though value investors can be divided into three distinct styles or groupings, this doesn’t change the core concept of value investing. We still buy stocks for less than their intrinsic values. Once we hold these stocks for a particular period of time, we sell them to make a profit.

The first style of value investing sits on one side of the spectrum. It is called “passive” value investing. This style would be associated more so with the type of work Benjamin Graham did. It basically entails the screening of stocks, using some predefined financial criteria, in search of a stock that is undervalued. The security is then purchased at the undervalued price and held, passively, until the market realizes this value and the price increases. The financial criterion used for screening stocks varies from analyst to analyst and is frequently debated. Some analysts make decisions based on ratios such as Price/Book Value, Price/Earnings or EV/EBITDA. Other analysts use cash balances, debt ratios, and even discounted cash flow projections to find this misevaluation. But the key here is that once the undervalued stock is found, the passive value investor will buy and wait.

In the middle of the spectrum is what is called “contrarian” value investing. This is usually the most common type of value investing and follows the principles and strategies of Warren Buffet. Just like any other value investor, the contrarian will buy the stock when it is cheap, but he will also specifically look for one that not only is cheap, but everyone else seems to think will move in the opposite way. Contrarian investing involves going contradictory to the way of the market. Sometimes a piece of news will be released that causes the market to irrationally panic and tank a stock price. This is where a contrarian investor would see the other positive information that everyone else seems to ignore and buy this undervalued firm. Contrarians will go the inverse way of the market, but they will only do it with good reason and not a willy-nilly sense of rebellion.

On the extreme other side of the spectrum is something called “active” or “activist” value investing. This style of investing involves buying a stock that is undervalued and then actively taking steps to bring their intrinsic profit to fruition. This active investing could include meeting with management to discuss various business initiatives, proxy voting in favour of value increasing actions, or even full private equity strides that involve entering the business, disposing of losing branches, and doing some restructuring. Their goal is to assist in the unlocking of the value; spin-offs, buys backs, liquidation, and even capital structure changes are types of active value investing. It is evident that this activist style of investing is quite time consuming and very involved. However, it still functions around the principles of buying something undervalued.

Regardless which type of value investor an individual is, it’s important to remember the second part of the equation in value investing. Not only must we purchase a stock that is undervalued, but we must also remember that in order for us to make our profit, we must sell this stock later at a higher price. We must be careful not to find something that is so deep in value, so contrarian, or so intrinsic that the market may realize it outside of our investment horizon. Or worse, may never realize it.