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Cheap shares: value investing is dead. Long live value investing!

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Broadly speaking, there are three main schools of investing. Growth investing involves buying shares in fast-growing companies. Nowadays, this often means investing in go-go US tech shares. Momentum investing is buying shares that have been consistently rising over time. Companies such as Tesla fall into this category. My favourite, value investing, involves buying cheap shares and holding them over long periods.

What are cheap shares?

For value investors, shares are considered cheap if they appear underpriced when measured against certain fundamentals. A company’s shares might be a bargain because they’re valued at less than its net assets per share. Second, companies whose yearly earnings are lowly rated — with low price-to-earnings ratios — also join the value watchlist. Third, businesses paying generous yearly cash dividends to shareholders often find their shares in the bargain bin.

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Value investing is dead

Bad news for lovers of cheap shares: value investing is in its worst slump in almost 200 years, according to this new report. The review, conducted by Mikhail Samonov of fund manager Two Centuries Investments, found that value investing is enduring its worst performance run since 1826. Since the global financial crisis of 2007-09 ended, growth investors have banked far greater returns than value investors.

Two market indices show how growth has easily outperformed value as Covid-19 rocked world markets. The MSCI index of global growth stocks has soared by almost a quarter (22%) in 2020. On the other hand, the MSCI global value index has dived 12%. Based on these indicators, growth investors have banked gains 34 percentage points higher than value seekers. That makes for grim reading for fans of cheap shares.

Long live value investing through cheap shares!

This news about the death of cheap shares doesn’t bother me though. In fact, it makes me more confident that value investing will again enjoy its days in the sun. That’s because of the power of ‘mean reversion’ (the tendency of trends to revert back over time towards their averages).

Nowadays, US growth stocks are pricier than at any time other than during the dotcom bubble that burst 20 years ago. Likewise, value stocks are so unloved today that it’s possible to buy shares on single-digit price-to-earnings ratios and/or double-digit dividend yields. Given that investing is about buying a company’s future, not its past, I’m convinced that cheap shares will beat growth stocks over the next decade.

I’d buy this bargain stock

The UK’s FTSE 100 index is packed with cheap shares due to Covid-19 and the prospect of a no-deal Brexit. But one stock stands out for me lately — oil giant BP (LSE: BP). At Monday’s close, BP’s cheap shares closed at a nice, round £2, down a shocking 60.9% over the past 12 months. BP’s stock is so unloved these days, it has dived 14%+ in the past month alone. However, on 5 November 2019, BP’s share price rose like a firework to hit 521.5p. That’s more than 2.6 times its current level.

While BP’s cheap shares may be unloved (even hated) today, it has survived greater crises than Covid-19. Given its spectacular under-performance, I think its shares must eventually rebound. In the meantime, value investors like me buying BP today can bank an 8.06% yearly dividend while they wait for post-pandemic normality. That’s why I’d buy BP shares today, ideally inside an ISA, to pocket this generous tax-free income and future capital gains!

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Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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