Value investing refers to finding stocks that can be purchased at a discount or at a lower price of what a company is actually worth (Tengler, 2003). Furthermore, it has been proven that this type of stock works better over the long term. As Williams (2018) stated, “Based on the study findings from Bank of America/Merrill Lynch over a 90-year period, growth stocks returned an average of 12.6% annually since 1926. However, value stocks generated an average return of 17% per year over the same timeframe” (para.5). Otherwise stated, small value stocks performed about 4.4% better than growth stocks over a 96 years period. The logical reason for this performance is that value stocks are less risky. Consequently, there is a bigger room for growth over time. Berk and DeMarzo (2017) explained that value stocks tend to have a positive alpha –meaning that value stocks tend to be positive and above the security market line (p.463). In other words, alpha shows the excess return and outstanding performance of value stocks.
There are two biases that investors tend to experience: familiarity bias and overconfidence bias. Familiarity bias occur when individual’s investments are concentrated in stocks from companies under the same industry and even businesses that are geographically close. In other words, lack of diversity is one of the causes that investors tend to fail. They feel more confident with the companies they know and they trade too much with them. In addition, “Psychologists have known since the 1960s that individuals tend to overestimate the precision of their knowledge” (Berk and DeMarzo, 2017, p.451). Therefore, investors fail when being overconfident when making their decisions. In fact, Berk and DeMarzo (2017) explained that men tend to be more confident than women in finance and investing decisions. As a result, men tend to trade more without considering the cost of trading; therefore, they get lower returns as results.
Berk, J., and DeMarzo, P. (2017). Corporate Finance: The Core (4th ed.). Boston, MA: Pearson Learning Solutions
Tengler, N. (2003). New era value investing: a disciplined approach to buying value and growth stocks. Hoboken, NJ: J. Wiley.
Williams, S. (2016, June 19). Growth Stocks vs. Value Stocks: Over the Long Term, Your Best Bet Is… Retrieved from https://www.fool.com/investing/2016/06/19/growth-stocks-vs-value-stocks-over-the-long-term-y.aspx.
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