The Economics of Value Investing

The investment CAPM provides an economic foundation for Graham and Dodd’s (1934) Security Analysis. Expected returns vary cross-sectionally, depending on firms’ investment, profitability, and expected investment growth. Empirically, many anomaly variables predict future changes in investment-to-assets, in the same direction in which these variables predict future returns. However, the expected investment growth effect in sorts is weak. The investment CAPM has different theoretical properties from Miller and Modigliani’s (1961) valuation model and Penman, Reggiani, Richardson, and Tuna’s (2017) characteristic model. In all, value investing is consistent with efficient markets.