Value Investing the Age of Big Data

An American-born investment strategy—with a cult following due to Warren Buffet’s phenomenal success employing it—Value Investing is the polar opposite of practices such as High-Frequency Trading. The one uses emotional discipline, critical analysis and long-term patience; the other, exploits complex algorithms and computational power. What is intelligent investing in the age of artificial intelligence?

In simplistic terms, what defines value investors is their pursuit of opportunities for purchasing an asset at a significant discount to its intrinsic value—that is, buying a business for less than what it is worth—thereby ensuring a margin of safety and profiting once the market comes around to reason.

While the method has evolved and been refined since the publication of Benjamin Graham’s classic text on the approach, The Intelligent Investor (1949), it remains based on this core, almost common sense, principle that largely ignores Wall Street’s constant excitation.

And, High-Frequency Trading is Wall Street at its most agitated: a large number of orders at very fast speeds using complex algorithms to analyze multiple parameters where traders with the fastest execution speeds are more profitable than those with slower execution speeds. Value Investing, on the contrary, takes it slow.

Enter the famed “Mr. Market”, a term coined by Graham, whom some describe as a manic-depressive advisor who, though emotionally unstable, will eventually name a company’s proper value. That’s when a Value Investor choses to listen to him—and choses to sell.

Graham describes Mr. Market as an obliging partner who “every day tells you what he thinks your interest is worth and furthermore offers to buy you out or to sell you an additional interest on that basis. Sometimes, his idea of value appears plausible and justified…often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.”

Mid-century, Graham has Mr. Market providing a daily offer of value—today, we have Mr. Market giving his questionable opinion every millisecond and through a myriad of means using new tools such as Artificial Intelligence (AI), Machine Learning and Big Data Analytics.

In some respects, such quantity of information places even more importance on human judgement. Given that 80% of the market’s capital is “trapped” in passive and/or reactionary vehicles such as ETFs, pension funds, closet-indexing mutual funds, and automated strategies, the ability to judge well in the direct investment of company shares is ever more weighted.  Warren Buffett has said of High-Frequency Trading: “They’ve gained an advantage by figuring out how the system worked and getting there first and that adds nothing to economic activity.”

Some value investors choose to use computational intelligence for their own means, developing automated analytical process. These can include, for example, using algorithms to forecast a company’s next four years’ full financial statements, which is then translated into fair value for comparing this to the current share price for the purpose of identify shares trading at a significant discount to intrinsic value.

In an era in which we have more information than ever before, we do not necessarily have a clearer notion of what to do with that information; in fact, an overload of it can lead to greater confusion when it concerns the right course of action.

The nature of a classic text such as The Intelligent Investor is that its wisdom is timeless—even, or especially, when time is dissected into milliseconds, microchips and multiplex algorithms.

Sources: The Intelligent Investor (Benjamin Graham, 1949), MOI Global, CNBC.