Value Investing: Tools and Techniques for Intelligent Investment

Chapter 34. Buy When it's Cheap – If Not Then, When?^[34]

Is valuation alone enough of a reason to buy equities? To assess this I have looked at how a 'value' investor would have done by buying US equities when they traded on a 10× Graham and Dodd PE over history. The curse of value (selling too early in a boom, and buying too early in a bust) is demonstrated. Buying at 10× meant buying on average four months before the market bottomed, and suffering a subsequent 20% loss. However, one only had to wait for a year on average before the market returned to the level at which it was purchased. This strikes me as a small price to pay for admitting that I won't catch the exact bottom except by luck. So buy when it's cheap and be patient.

• Is valuation alone enough of a reason to buy equities? In the short term, valuation isn't a binding constraint. Cheap stocks can always get cheaper, and expensive stocks can always get more expensive. However, it is the primary determinant of long-term returns. Thus with the UK and European markets currently trading at revulsion level valuations of 10× Graham and Dodd PEs, there is a compelling investment case for a long-term investor.

• Even better news is that buying markets when they are cheap limits the downside for a patient investor. Historically, investors haven't ever lost money on a 10-year horizon when they purchased equities in the lowest quartile of valuations.

• However, as Keynes noted, long-term investment 'is so difficult today as to be scarcely ...