Chapter Eight: Become a Quality-Driven Value Investor
Real-time final draft manuscript | Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises
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Chapter Eight
Become a Quality-Driven Value Investor
Most professions or disciplines require mastering no more than 6 to 8 fundamentals for long-term success. Stock market investing is no exception.
As widely reported, many in the financial services industry and media believe that buy-and-hold, quality-driven value investing is obsolete.
If that’s the case, then why are many of the top investors in modern history focused on quality and value?
William Browne, Warren Buffett, Mario Gabelli, Joel Greenblatt, Seth Klarman, Peter Lynch, Howard Marks, Bill Miller, Charlie Munger, Michael Price, John W. Rogers Jr., Charles Royce, Walter Schloss, Sir John Templeton, Geraldine Weiss, and Martin Whitman are all legends.
These renowned value investor household names remind us of the importance of owning common shares in enduring companies with wide safety margins, the most reliable way to build portfolios that achieve alpha.
Despite constantly evolving and persevering, anything with promise has its setbacks in popularity or delivery methods. Nevertheless, there is nothing equal to quality-driven investing for individuals aiming to build and sustain an enduring portfolio, funding the essential milestones in the lives of loved ones.
Quality-Driven Value Investing Explained
I asked ChatGPT to define “quality value investing.” Its response matched my goals for researching and writing about alpha-generating opportunities for the Quality Value Investing newsletter and this book. It emphasizes the company’s current wealth and the stock’s current value.
Quality value investing is an investment strategy that combines value investing principles with a focus on high-quality companies. This approach involves finding undervalued stocks of companies with strong fundamentals, such as solid financial health, sustainable competitive advantages, and steady earnings growth. The main aspects of quality value investing include:
Fundamental Analysis—Assessing a company’s financial statements, including balance sheets, income statements, and cash flow statements, to determine its intrinsic value.
Competitive Advantage—Investing in companies with a durable competitive edge, often called an “economic moat,” can include brand strength, proprietary technology, network effects, or high customer loyalty.
Management Quality—Evaluating a company’s management team to ensure they can sustain performance and promote future growth.
Financial Health—Seeking companies with solid balance sheets, low debt, and high returns on equity (ROE) and invested capital (ROIC).
Valuation—Finding stocks trading below their intrinsic value, providing a margin of safety. This involves comparing the current stock price to the company’s intrinsic value calculated using specific valuation methods.
Long-Term Perspective—Taking a long-term investment approach, focusing on companies that can grow and create value over time rather than pursuing short-term gains.
Investors aim to reduce the risks linked to value traps by focusing on quality stocks that seem cheap but lack solid fundamentals. This balanced strategy strives to deliver steady, dependable returns by investing in undervalued yet fundamentally strong companies.
—ChatGPT, July 2024 (edited for clarity)
On the Recurring Death of Value Investing
Value investing is never dead. It’s less popular than short-term growth stories and low-quality cigar butts. Investing in enduring enterprises at reasonable prices remains a superior strategy.
Although it is important to emphasize that I remain a dedicated, quality-focused value investor, the investment approach was out of favor on Wall Street during the momentum-driven growth phase following the Great Recession bull market. As a result, it became more difficult to attract readers who, instead, trusted the unreliable predictive analysis and excessive business modeling of the financial services industry.
Toward the end of the epic bull market, it became fashionable for veteran value investors to bite the bullet and invest in more speculative, non-dividend-paying growth stocks. In other words, this time was different — until it wasn’t.
For better or worse, I avoided following trends like momentum trading driven by speculation. Instead, I focused on researching and buying stocks of companies that are not only out of favor but also well-managed, with histories of outperforming the S&P 500. The results were primarily alpha-generating.
Wall Street struggles to generate Hamptons beach house-size bonuses on buy-and-hold quality value investing. Instead, it promotes speculative trading strategies that generate fees used to build those summer cottages.
Of course, there are different interpretations of traditional value investing or multi-bagger compounders bought at attractive prices.
Trading value stocks is like buying cigar butts or shares of companies with questionable fundamentals, speculating on them, and then selling based on expected, or worse, hoped-for, corporate, industry, or macro-driven events. In contrast, quality value investors keep adding new ideas to their portfolios that offer strong prospects for growing capital gains and dividends, protected by adequate safety margins to safeguard principal during the inevitable market declines.
Future returns are often uncorrelated with past performance. Nonetheless, quality-driven value investing aims to outperform the benchmark over long periods—seven to ten years or more—recognizing that monthly, quarterly, and annual results are subject to market fluctuations. This market reality influences irrational investor behavior in response to unexpected events. It is more effective to seek the benefits of compounded returns protected by sufficient safety margins.
The epic bull market of the 2010s and early 2020s seemed unstoppable, driven by non-dividend-paying growth, high-yield forward dividends, cryptocurrency, and other shortsighted investment strategies. Some market experts questioned the lasting impact of value investing or predicted its imminent downfall. A bull market for the ages sparked the debate as growth stocks, momentum trading, trend-following, and forward high-yield dividend equities, among other speculative portfolio strategies, outperformed the more conservative quality value approach.
Quality value investing is too long-term and low-cost for a shortsighted, overly complex financial services industry focused on collecting exorbitant fees and bonuses from its followers. Nonetheless, trying to predict trends, catalysts, and macro events that consistently lead to profitable trades resembles a game of chance more than a legitimate professional practice. Despite the noise, fundamentals and price-sensitive investing prevail because quality at value matters in everything we buy, hold, or sell.
Investments in wide-moated, mostly dividend-paying companies at reasonable share prices tend to last long beyond the scrap heap, where eternal bull markets for the ages dump the portfolios of investors chasing quick money, again caught up in the euphoria of “This time is different.” History argues otherwise.
Value investing is neither dead nor dying and remains a superior strategy. We are comfortable recognizing that quality and value persist through all market cycles, whether bull, bear, or range-bound.
The Downside of Value in Bull Markets
The main risk to the quality value investing model is that shortsighted growth and income investors dominate the stock market.
Chasing the elusive market bubbles has been a fundamental part of investing for both Wall Street professionals and Main Street do-it-yourselfers since stock trading started. Human nature drives us to jump in once we think we’ve outsmarted the market by predicting a swing, trend, or deciding to go long or short on a company or sector. Confident that we can figure this all out, we get caught in the endless cycle of predicting and trading without restraint.
As validation, there are always reputable external influences on our focus, such as market trends. The Federal Reserve helped keep interest rates low until it changed its stance. Before that, the transition was from government deregulation of the housing market, which enabled widespread homeownership. This socioeconomic phenomenon allowed opportunistic investment banks to package mortgages into marketable securities, thereby creating more risky mortgage dollars to lend to marginal home buyers.
Before high-rated mortgages—despite lacking documentation and income—there was support from the capital markets, characterized by free-flowing investment in dot-com ideas that were just concepts. Before that, junk bonds helped finance mergers and acquisitions that seemed impossible before. The market is the most considerable risk to an investor’s capital. However, it is also a valuable resource for finding unique company or market-wide value opportunities. Dedicated quality value investors remain rational, self-disciplined, and patient, even without knowing when or how those opportunities will appear.
Prepare for the upcoming downturn by holding dry powder, such as FDIC-insured cash or its equivalent. Take advantage of the potential rise in stocks of excellent companies that are becoming value-priced due to the market’s sudden extreme aversion to risk among short-term investors. Rest assured: When market crashes happen, speculators relying on trend-following, momentum trading, high-yield dividend investing, and other emerging trading fads will quickly retreat.
Our workdays are akin to market downturns, creating value opportunities to initiate or expand positions in targeted businesses. The upcoming upturns are our paydays. Although unpredictable, the inevitable days of reckoning are certain.
Rational, quality-driven value investors never have to worry about failed short positions, declining fund assets from performance chasers leaving, or useless self-doubt fueled by 20/20 hindsight of missing out on fast growers, high-yielders, and cryptocurrencies when they trend upward.
Rational, disciplined, and patient investors can be reassured that quality and value ultimately prevail in financial markets, just as they do in farmers’ markets.
Why the Trend is Often Not Our Friend
By definition, trend followers overlook the underfollowed player in an underappreciated industry.
Nonetheless, following the trend or practicing momentum investing is fleeting, favoring shortsighted, speculative trades that come and go with market cycles and fads. Common sense suggests that a series of short-term momentum trades is needed to achieve the same potential profits as a few long-term investments in wonderful companies bought at reasonable prices. We purchased substantial long-term holdings at value prices because traders sold them off during a negative trend.
Buy shares of businesses whose products or services are consistently in demand, yet their stocks trade at bargain prices due to temporary market mispricing.
Skeptical, nearsighted investors cite political grandstanding, trade wars, commodity pricing dilemmas, livestock supply issues, occasional product recalls, and other minor grievances as justification for shortsighted momentum trades and trend following. Conversely, being open to a compelling counterargument to an investment thesis is essential. For example, when quality-driven value investors hear, “Stay away from car companies,” the stocks of fundamentally sound, durable auto industry companies suddenly become of curious interest.
It is surprising how the investment world, overall, believes the current market—whether bull, bear, or range-bound—is somehow different, ignoring that business and market cycles occur randomly. Having the newest investment fads to rally around is the flawed way each market cycle is distinguished.
Prioritize the general perception of intrinsic value over specific estimations. Be cautious of precise price targets, earnings forecasts, and other detailed figures from sellside and buyside analysts’ sophisticated models when assessing the gap between market price and underlying value.
When reading, “XYZ is trading at a 40 percent discount to intrinsic value,” remember how Wall Street justifies huge fees and bonuses with unnecessary speculative predictions. If these market pundits were often right instead of wrong, we’d get rich by following them. Before accepting the prediction as fact, do your research.
Overanalyzing or setting price targets can cause trouble for retail investors—and even professionals—when timing trades. The paralysis caused by over-analyzing publicly traded companies and their stocks leads to extreme shorting or put options trades, as bad news seems to exist in every security. Whether those projections will happen is anyone’s guess.
Become a reformed investor by learning from experience. Slow and steady, quality-focused value investors understand that stable companies tend to appreciate over the long term, while active traders who react quickly to good or bad news often get penalized in the short run. We can chase popular stock trends, which can pose a danger to our portfolio, or instead invest in excellent companies for the long haul and benefit from compounded total returns with a healthy margin of safety.
Rational, disciplined, and patient investors focus on quality and value.
Master the Fundamentals
Most careers or fields need mastering only 6 to 8 key fundamentals for lasting success.
These are my key fundamentals for quality-focused stock market investing.
Stick to the facts by investing in a company’s current wealth and the present value of its stock price.
Be cautious of excessive predictive analysis and business modeling, as they tend to generate fees rather than true alpha.
Act as a partial owner of people-centered businesses instead of a trader of faceless stocks.
Investing is one of those rare pursuits where staying sedentary can be more profitable than being active.
Read often and maintain a journal of our investing journeys, highlighting lessons learned.
Pay ourselves first by investing an agreed-upon discretionary portion of our households’ gross income in publicly traded companies that are understood and admired.
Prioritize health over wealth. No matter our resources, if money can solve a problem in life, then it’s not a real issue. If money can’t fix it, then we genuinely have a problem.
Diversify or Concentrate?
Remember, portfolio diversification benefits the financial services industry more than the investor. Consider the alternative of concentrating.
Diversified portfolios inevitably include both high-quality and low-quality holdings that generate fees rather than produce alpha. Once again, exhaustive predictive analysis and excessive business-modeling are illusions of a fee-driven financial machine.
On the contrary, concentrated portfolios of mostly dividend-paying, fundamentally sound holdings bought at reasonable prices generate alpha more than they produce fees.
Stay true to the original good intentions of the financial markets by investing in publicly traded companies through affordable partial stakes. This approach connects investors with Wall Street’s more trustworthy role in supplying necessary capital to support worthwhile businesses.
Boost your chances of achieving stock market alpha by becoming a quality-driven, value-focused investor.
Next in Quality Value Investing | Chapter Nine: Set Strategic Financial Goals
Chapter Eight: Become a Quality-Driven Value Investor is copyright 2025 by David J. Waldron. All rights reserved worldwide.
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