Value Investing with Mutual Funds

Many of the most famous and successful money managers have been value-oriented investors. These investors believe that they can outperform their peers and the market by investing in undervalued (or underpriced) stocks. This strategy, broadly called value investing, is pursued when the manager believes that the market price of the stock is below its true value.

Value investors believe that they can outperform the market because these undervalued stocks should provide higher returns than fairly- or over-priced stocks.

Some of the best support for value investing has been empirical evidence in academic research; Professors Eugene Fama and Ken French originally discovered that value stocks historically have outperformed non-value stocks over the long-term, and find evidence that this is the case throughout the world.

Value investors also gain comfort from the fact that some of the most famous investors are value investors—Ben Graham, the “father of security analysis” was a value investor, and Warren Buffett, possibly the world’s greatest and most famous investor, followed in his value-oriented footsteps. Other famous value managers and their funds include Bill Miller (Legg Mason Value Trust), Marty Whitman (Third Avenue Value Fund), and John Neff (Vanguard Windsor Fund).

So with all the hype about value investing, how can you find a good value fund? The most important thing is to find a value-based fund with a long history of successful performance.

Of course, past performance is no guarantee or predictor of future performance. One easy route is to find and compare value-based funds and fund families that promote the value-based approach. For example, all three of the Oakmark mutual funds are value funds—they only differ in aspects such as geography and company size.

Another approach may be to compare a mutual fund’s statistics and multiples to the average market multiple to see if the manager has a value orientation. One telling sign of a value investor is low Price-to-Book stocks. The Price-to-Book (P/B) multiple expresses the relationship between the market capitalization of the stock relative to the book value of equity.

A low P/B stock (typically with a ratio under 1) implies that the market price is lower than the book value of company, i.e., a company with a per share equity value of $10 trades for only $8. This low P/B ratio is a hallmark of many value investors, and in fact is the metric that Fama and French used when conducting their research to find that value stocks outperform non-value stocks.

The evidence for value investing certainly is powerful. By finding a value-oriented mutual fund manager you trust who has a history of successful value investing, you may be able to give your portfolio the edge it needs to beat the market.