CAPM assumes a positive correlation between risk and reward. The exact opposite is true with value investing. If you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case.
One quick example: The Washington Post Company in 1973 was selling for $80 million in the market. At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more. The company owned the Post, Newsweek, plus several television stations in major markets. Those same properties [were] worth $2 billion [in 1984], so the person who would have paid $400 million would not have been crazy.
What’s the social function of Warren Buffett’s style of value investing? It saves worthy, established companies from being unfairly shorted below a base sanity valuation.
Consider that large companies have more employees, more customers, and more suppliers. Saving them is like stopping a large swath of forest from burning.
But for my personality type, I’m not as interested in big, publicly held companies. Maybe it’s unreasonable of me. But I am more for shorting the big dogs (the over-valued ones) and for longing the small guys (the ones that just need to be given a chance).
I think that’s more exciting and more interesting. Maybe it’s also more speculative; maybe you have less control over the risk.