Describing investment styles
Value
Value is probably the most well-known investment style, which dates back to the British-born American economist and professional investor, Benjamin Graham. A value investor buys assets that are undervalued and sells assets that are overvalued according to some valuation metric (Kolanovic and Wei, 2013: 39). Despite the fact that this approach appears straightforward, a great deal of uncertainty remains with regards to determining the fair value of a security (Jensen-Gaard, 2013: 27). Value stocks are considered to be cheap as investors underestimate their growth prospects (Ang, 2014: 233), whereby value is captured by various accounting measures such as: price to book, earnings to price, sales, book value, cash earnings, net profit and dividends (Bender et al, 2013: 5). Furthermore, a value strategy aims to capitalise on the mean-reversion of a securities price to its ‘fair value’, where value relies on the premise that prices are temporarily driven away from their ‘fair value’ by either behavioural or liquidity effects (Kolanovic and Wei, 2013: 39).
Momentum
Momentum can be characterized as the tendency of securities, in every market and asset class to exhibit persistence in terms of their performance (Asness et al., 2015: 31). In addition, momentum investors buy stocks that have performed well and sell stocks that have performed poorly. The momentum effect relies on the phenomenon that stocks that have done well previously, will continue to do well, while stocks that have done poorly, will continue to perform poorly (Ang, 2014: 235). The existence of a price momentum effect goes against the efficient market hypothesis which states that past prices alone cannot predict future returns (Kolanovic and Wei, 2013: 34). The theory underlying the premium attributed to momentum is very much undecided, where there is no satisfactory efficient based market theory to explain why a momentum premium exists (Bender et al., 2013: 25). The most widely cited theories are all behavioural, where investors either over-react or under-react to market news which leads to price momentum (Bender et al., 2013: 25).
Growth
Growth investors look for stocks which they believe have the ability to outgrow the market. Contrary to value investing, which focusses on observed facts, growth investors focus on the future prospects of a company. Growth can typically be described by the following accounting measures: asset growth, growth in earnings per share and sales growth. Advocates for growth investing argue that companies with high growth rates will be able to sustain or even improve their growth rate in the future, and in so doing continue to outperform the market going forward.
Quality
“Quality, unlike value, has no universally accepted definition” (Novy-Marx, 2012: 1). The main challenge in terms of selecting quality stocks is how to define the quality factor objectively and consistently (Bender et al., 2013: 27). Quality investors typically look for stocks that are characterized by low debt, stable earnings growth and other ‘quality’ metrics such as: high return on equity, dividend growth stability, strength of a company’s balance sheet, financial leverage, cash flows, strength of management, and accounting policies (Bender et al., 2013: 5). These quality metrics provide a measure of strength in terms of the underlying business, a competitive advantage from an industry perspective and management’s ability to efficiently allocate capital. Investors who advocate for following a quality strategy believe that the market undervalues firms with a high and sustainable profit profile (Jensen-Gaard, 2013: 13).