Value Investing: 5 Tips to Consider in 2016

There's a classic stereotype about value stocks struggling more than growth stocks during bear markets. This held up in 2015, which saw the iShares S&P 500 Growth ETF (NYSEARCA: IVW) and the Russell 1000 Growth Index each gain over 4%, while the S&P 500 Value ETF and the Russell 1000 Value Index each dropped at least 4%. With another sluggish year projected for 2016, value investors should consider these tips to maximize their portfolios in an uncertain environment.

1. Don't Lose Sight of Diversification

Diversification is the first principle of every Investing 101 class, but even seasoned investors can lose the forest for the trees. Don't diversify randomly, however. Look for asset classes that tend to move in opposite directions.

Benjamin Graham famously said that even the most ambitious investors should hold no fewer than 30 stocks, and even that only works when the sampling is random. Hundreds of stocks, each intentionally selected, are preferable. These can include mutual funds and exchange-traded funds (ETFs).

2. Ignore the Noise: Invest for Your Time Horizon

It might be easy to stay patient with underperforming companies when they only make up a small part of your portfolio, but it's harder when the entire market is sideways or negative. It's human nature to pay attention to the immediate and the short term, but statistically, short-term movements are noise for value investors.

The macro environment can create a lot of seeming outperformance or underperformance, but value investing is about ignoring the psychology of the moment and focusing on a company's assets, earnings, history and long-run viability. At times, this means being less active after you've done your diligence.

3. Look Beyond Cheap: Find Broader Industry Sustainability

Value investors can be lured into a trap whenever an attractive price-to-earnings (P/E) or price-to-book (P/B) ratio pops up. This can be tricky even in the best of times, since strong P/E or P/B ratios vary from sector to sector and country to country. Sometimes, however, a company is trading at a discount for meaningful reasons, and it isn't really a good value play.

4. Occasionally Peek Outside the Value Bubble
Review financial statements thoroughly, including carried debt and how leverage ratios compare to others in the industry. The cost of financing may keep rising if interest rates increase, making debt servicing riskier. Sector fundamentals also matter, particularly for sectors exposed to commodity prices or that are dealing heavy in international trade.

Every value investor has heard the stories of value legends: Benjamin Graham, Warren Buffett, Charlie Munger, John Templeton, Irving Kahn, Bill Ackman, Daniel Loeb and many others. It might be tempting for a younger, impressionable investor to dogmatically follow in the footsteps of giants.

Of course, few value investors can recite the lists of missed opportunities and blown investments than inevitably follow every money manager around. Value investing is not a magic recipe, and it's not a catch-all for perfect fundamental understanding.

Consider Ackman, the outspoken chief executive officer (CEO) of Pershing Square Capital Management, an activist hedge fund. Ackman is a devoted follower of fundamental tenets, but his devotion ended up costing him more than a decade of strong technology returns. Technology companies tend to perform notoriously poorly on traditional value metrics. As Ackman himself points out, it is challenging at best to construct an economic moat in tech.

Value investing principles can provide an excellent guideline for evaluating companies, but a wise investor doesn't become limited by money monotheism.

5. Read and Learn More

Investing is full of traps and often involves consequential amounts of risk-taking. Value investors should be active readers – not just of current market data, but of value investing theory and its pioneers. There's no sense in reinventing the wheel if someone else is already building cars around four of them.

Younger investors might check out the new "Empowered Millennial Investor: A Beginner's Guide to Investing" by Michael Pawlowsky, and Phillip Fisher's "Common Stocks and Uncommon Profits" is a classic and value favorite.

By Sean Ross

Source: http://www.investopedia.com/articles/investing/042516/value-investing-5-tips-consider-2016.asp