CIO Insights

FI RST Q uarter 2011

Key Success Factors for Value Investing

Value-based investment strategies are sometimes perceived as old fashioned and less
capable of long-term wealth generation than growth-based strategies. But history—
especially over the past ten years—demonstrates that a better analogy might be the
tortoise (for value) versus the hare (for growth) where slower but steadier could be a
more attractive approach for long-term investors.

The Fundamental Tenets of to value managers. These are companies

Value Investing which seem inexpensive based on attractive
valuation multiples. But their underlying
One thing that distinguishes value-based
fundamentals usually reveal businesses
investment managers from their growth-
in secular decline (e.g., newspaper Phillip N. Davidson, CFA
oriented peers is their strong focus on the
publishers) or broken business models Chief Investment Officer
balance sheets of companies in addition U.S. Value Equity
(e.g., book retailers). The ability to avoid
to earnings and cash flow. A holistic view
value traps is probably one of the most
of balance sheet fundamentals considers
distinguishing characteristics of successful
items that don’t necessarily appear (such
value managers and reflects a truism that
as operating leases for large retailers) but
what you don’t own in your portfolio is as “Fundamental bottom-up
ought to be factored into calculations of
important as what you do own. Knowing
capital structure and leverage. In the real company analysis is the
when to buy and sell a good value company
world, businesses of every kind encounter
is also crucial. We don’t fall in love with cornerstone to value investing
setbacks and unforeseen challenges. When
our investments and understand that even
these impact sales and earnings, a healthy and requires understanding
highly successful companies go through
balance sheet is a strong foundation and a company’s ability to sustain
periods of over- and under-valuation.
safety net for value investors.
an attractive long-term
Portfolio construction is another crucial skill
As value managers, we generally avoid rate of return.”
for successful value managers. Good value
companies with high leverage. We look for
managers understand the risks they are
businesses with strong and sustainable
taking and expect to be rewarded for these
business models and value propositions, and
risks based on superior insight and analysis.
we avoid companies where management
To use a baseball analogy, most value
has made—or is making—poor capital
managers look for a lot of singles versus
allocation decisions. These points reflect
swinging for the fences based on a handful
a fundamental bias toward quality and
of active bets. We believe a key success
sustainability. We are interested in
factor is to limit active risk and construct
companies’ performance over the entire
portfolios with positive expected excess
economic cycle—not just how well they can
return but less volatility than the benchmark.
do in the good times. Companies in highly
cyclical industries can appear attractive Finally, all these insights depend on having
as their sales and earnings accelerate in a proven and disciplined investment process
a growth phase, but understanding their run by seasoned professionals acting as
performance and value over their entire a team. Along with deep experience, it is
earnings cycle is what matters. Fundamental also critical to strive for continuous process
bottom-up company analysis is the improvement based on ongoing learning.
cornerstone to value investing and requires And that depends on one final hallmark of
understanding a company’s ability to sustain a successful value manager: Never become
an attractive long-term rate of return. overconfident in the face of a constantly
changing economic environment and
Stock Selection and Portfolio financial markets. The opinions expressed are those of Phillip N.
Davidson, CFA, and are no guarantee of the future
Construction performance of any American Century Investments
Successful value managers are excellent portfolio.
stock pickers. Value traps are anathema
For educational use only. This information is not
intended to serve as investment advice.

IN-FLY-70272 1101 ©2011 American Century Proprietary Holdings, Inc. All rights reserved. Non-FDIC Insured • May Lose Value • No Bank Guarantee