Value Investing: Tools and Techniques for Intelligent Investment

Chapter 8. Learn to Love Your Dogs, or, Overpaying for the Hope of Growth (Again!)^[8]

The promise of growth has a seductive allure, much like the siren's song. However, it rarely pays for investors to do what feels comfortable. For instance, star stocks (those with good historic and forecast growth) have underperformed dogs (poor past and forecast growth) by around 6% p.a.! While good stories are entertaining, they aren't a substitute for a proper investment process. Investors would do well to learn to love the dogs and shun the darlings. The market's current love affair with all things mining related may well prove to be yet another example of overpaying for the hope of growth.

• While the zealots of market efficiency would like us to believe that value outperforms because it is riskier than growth, those of us working in the behavioural field tend to think it stems from investors persistently overpaying for the hope of growth. Recently, we showed that the risk-based explanations for the value premium didn't stand up to scrutiny. The behavioural evidence looks much stronger (but I am biased!).

• If investors regularly overpay for the hope of growth, then we should see star stocks (those with past and forecast high growth) underperform dog stocks (those with low past and forecast growth). This is exactly the pattern found in the data. In general, dogs outperform stars by around 6% p.a. – not bad since we have ignored explicit valuation measures.

• It might seem unusual for me to be using ...