The Death of Value, Not So Fast!
Much has been written over the past few years about the “death of value investing”. Whenever we hear “the death of anything”, we try to search out a contrarian opinion, as death seems a bit too certain for our taste. As such, sub-advisor Tweedy Browne’s most recent Annual Letter addresses the topic, with salient points below. (Emphasis by Madison)
Everything should be made as simple as possible, but not simpler – Albert Einstein
“The value investing community is once again being taken to the woodshed in the financial press, as formerly reliable value metrics such as low price-to-book (P/B) and low price-earnings (P/E) ratios have proven of late not to be as profitable as simply paying up for disruptive technology stocks.
As we have mentioned in recent letters, this is the third time in the last 18 years that the value style of investing has been declared compromised at best, and dead or dying, at worst. We have now entered the 10th year of a highly resilient and seemingly never-ending economic expansion. One only has to think back to the tech bubble in 2000 and the peak of the credit and real estate cycle in 2008. We all know what followed these prior euphoric periods, but memories remain short, particularly when the valuations of risk assets are gaining momentum.
Embedded in this denigration of value is, in our view, a misunderstanding of what constitutes true value investing. For example, we believe the common practice of characterizing investment managers and their investment styles as either “growth” or “value,” based solely on a few valuation metrics such as P/B value and/or P/E is inherently flawed. These valuation metrics, by themselves, fail to take into consideration important company attributes that are critical to a rational and comprehensive assessment of a company’s intrinsic value – attributes such as a company’s industry dynamics, prospects for growth, balance sheet strength, culture, management quality, capital allocation record, customer relationships, brand power and patents and risks, among a host of others. These more qualitative characteristics are extraordinarily difficult to measure, but are often determinative in our assessment of a company’s intrinsic value.
Furthermore, the proliferation of “asset-light” and service-based companies over decades has decreased the usefulness to us of a metric such as book value as a primary anchor in assessing undervaluation, as it has led to fewer companies trading at or below book value. Moreover, book value per share can become untethered from intrinsic value when companies buy back their stock at prices above stated book value. Warren Buffett addressed this in his latest annual letter to shareholders of Berkshire Hathaway, when he announced that Berkshire would no longer report its annual change in book value in referencing the company’s performance.
While we often use valuation metrics such as low P/B value as screening tools to uncover stocks for further study, low P/B is never the sole reason we purchase a stock. In certain types of businesses, such as banks, insurance companies, and other deeply cyclical businesses, low P/B value can be a relevant, useful and reliable indicator of undervaluation. However, even in the context of net-asset-based valuations, rigorous security analysis, in our view, calls for an examination of a myriad of other factors, not the least of which is a company’s growth prospects.
As noted above, on top of all of this quantitative analysis, in assessing valuation we also examine a plethora of qualitative characteristics, and also examine what company insiders are doing with their own capital when it comes to purchasing (or selling) shares in their companies. In our opinion, determining whether a potential investment is a “value” or not is more than simply a function of its price in relation to book value or its price in relation to earnings. We still strongly believe that price-sensitive security selection, combined with qualitative judgment, continues to offer investors the best path to long-term outperformance.
The compulsion to pigeonhole investment advisers as “value” or “growth” managers based on a few simple value metrics is not new. Warren Buffett addressed the issue 25 years ago in Berkshire Hathaway’s 1992 annual report. We believe his view is as relevant today as it was back then:
But how, you will ask, does one decide what’s attractive? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.
We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as a positive.
In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor in our view financially fattening).
Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase.
We would caution investors to be leery of the tendency by some in the financial press to use simple “value” heuristics to characterize investment advisers and their investment portfolios, and to keep Warren’s words in mind before sounding the death knell for a form of investment that has proven to be reliable and profitable over decades.”
Important Note: This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. The opinions expressed herein are those of the named advisors at the time written. Actual economic or market events may turn out differently than as presented.