S EC What If Value Investing Is A Little Bit Dead?

I am not sure that it is, but I would like to explore some of the arguments that it may be. I have come across enough articles over the last year or so to suggest it could be broken, or even dead. If it is does that just mean as value investors we may need to tweak our approach slightly?

On the one hand, you don’t want to abandon your investing approach all of a sudden. Then again you don’t want to have your head in the sand and not be open to slight tweaks.

Now let’s get one thing out of the way before I delve into this post. I realize value and growth investing may be “joined at the hip” as many would say. For simplicity now let’s just think of value investing more about some simple metrics such as low price to book or price to earnings ratios. Debating the differences in styles is a whole other topic!

This topic came to mind as I recently read an article discussing the underperformance of value investing strategies. It was from “The Economist” so one thing that came to mind is the theory that major news publications may emphasize market trends at key turning points.

I also thought that plenty of the points made about value investing having a rough trot could have been made in exactly the same way in early 2000. I re-read the article asking myself at the same time could this exact piece have appeared just before the dot com bust?

Now, this article is far from saying value investing has stopped working. It is fair to say it reflects that it is out of fashion. I don’t think the article discusses anything different from what I tended to read in 1999 / early 2000.

Why am I using this date as a reference point? Well after early 2000 the dot com bubble burst and for the next decade so-called value investing trounced the returns of growth investing.

Another article I came across this year I thought was an excellent read because it came from an investor trying to avoid confirmation bias. That is a value investor trying to debate the case against value stocks.

I still wonder whether similar arguments here were also made in the dot com bubble. Although I may think the arguments may be similar, I think the author makes some very good points though. In particular, as to why the arguments could have become more compelling now.

Should we be asking is it different this time? Maybe value investing won’t rebound from its slump like it did after the tech boom ended?

The case against value stocks

I shall quickly note the 5 headings in the post above on why value investing may not work so well going forward. Were the same arguments around in 1999, and have these 5 key arguments become more compelling now?

If we subscribe to the theories made, are there some tweaks that value investors can make to put the odds more in their favor?

[1] The World is Different

The argument here is that central banks are now interfering in an unprecedented way. This is a game changer in encouraging speculation so who knows when value may come back into fashion.

My thoughts - There is no doubt the level of central bank intervention is far more apparent than in 1999. Having said that though I recall similar arguments being made back then. The “Greenspan put” was a reason at the time why you should shun value investing. There were no shortage of critics arguing the Fed kept monetary policy too easy after certain events. These included the ’87 crash, the Asian financial crisis, LTCM crisis, and Y2K threat. This was supposedly a reason that speculation would continue and favor growth investing.

How can value investors respond? – I see the best response here is at the margin to not to be too cute in waiting for the ultimate dirt cheap level to enter in a stock you like. In 2009 I remember many compelling arguments why the market had much further to fall. It centered around the chart of historic CAPE ratios in the US.

I saw a lot of investors staying heavily cashed up as surely we would soon see the CAPE P/E of the market go at least down to ten. That never happened though. Perhaps central bank intervention is the reason here. If we wait for all the ducks to line up we may end up with too much in cash for long periods. I have noticed a fair share of value-style investors that have carried higher than normal cash weightings for longer than normal periods.

[2] Too Many People Are Doing It

The argument is that it has so commonly been mentioned that value investing works, that too many active funds have tried to exploit it. Has the alpha been eaten away?

My thoughts – I think you could say that this argument is more compelling now with the amount of smart beta ETFs around. They can attract large amount of AUMs and screen for basic value tilts in liquid stocks quite easily. This is more apparent than in 1999.

How can value investors respond? – I would suggest staying clear of large-cap US stocks that appear as classic value stocks. This is probably the area where the easy alpha may have been exploited already. There are probably some good US large cap value ideas there, but on average can you pick them and stay out of enough “value traps”?

[3] The Capital Following it is Becoming More Permanent

The argument here is that the behavior of value investors is improving in having the discipline to stick with the strategy. That is, what makes it work is other investors capitulating with the strategy at the wrong time. This leaves bargain stocks to be scooped up by those who have the patience. Yet if everyone is patiently sticking with value investing for the long term, then when do such bargains pop up?

My thoughts – I am more skeptical on this argument as to me it implies that human nature is changing. I doubt we will witness geat improvements in the investor psychology of the masses. There is always plenty of new investors coming onto the scene likely to make the usual beginner mistakes of panicking at the wrong time.

Once again though I can see a point that makes the argument more compelling this time. The asset management industry may have improved at selling the point of value investing working over the long run. Perhaps the clients are more willing to stick to the strategy for longer than they used to.

How can value investors respond? – Arguably this just involves sticking to a value strategy now for a bit longer. Perhaps above just explains why the underperforming run of value managers has gone on for so long. Maybe we have not seen a capitulation in value-based strategies. Is this just around the corner?

There will no doubt still be bouts of panic. Despite the strong markets as I write now, we have still had a little nervousness as recently as in Q4, 2018. Part of what seems to have assisted this year has been dovish central banks globally, which ties into point 1 earlier. We have still seen a few bouts of panic and the VIX spiking on several occasions since the 2008 bear market. As value investors maybe we need to be quicker in pouncing during these opportunities and running those cash levels down.

[4] Big Data and Rising Computing Power Are Leading to More Value Traps

This refers to the sophisticated use of computing power that puts you ahead of researching via basic valuation metrics. The example being say a large old bricks and mortar retailer appearing to have a cheap valuation. Yet then you apply a sophisticated analysis of parking lot numbers being down. Or you get the heads up from credit card providers that indicate transactions may be slowing. Meanwhile, the rest of the market can be slow in discovering these are value traps.

My thoughts – On one hand it makes sense because funds management became a great industry to get into in the 90s. This no doubt lead to intense competition between active managers over time. You often read about veteran fund managers in the US speaking about it being more difficult there nowadays to spot opportunities in comparison to the 60s and 70s.

The intense research they undertake no doubt crowd out many opportunities. A similar argument could have been made in 1999, although perhaps the technology available now crowds out even more opportunities with all the stock filtering one can do.

One thing to keep in mind though is the general shift of money away from active to passive strategies in the US in recent years. This could be an argument that better opportunities to add value may come about in the future from this trend.

How can value investors respond? – The level of competitiveness of fund managers using sophisticated research is less I assume in markets other than the US. Likewise the smaller we go with company sizes we invest in it should be less competitively researched.

Hard work if one also has the time could pay off in small caps. For example, some companies may have assets on their balance sheet conservatively valued. Do accounting methodologies mean some tangible assets are still undervalued at cost? It may escape the radar of some investors if they are only screening by the reported NTA.

Or are companies that are generating improving cash flows under the radar? Perhaps such improvement is yet to show up for investors filtering based on profits. Or they may be excluded if they are filtering out companies with relatively high historical debt levels.

Now I imagine many well-researched fund managers are all over this type of thing. That is particularly when it comes to mid-cap or large-cap stocks in the US. If you are an individual investor hunting for small caps though it may throw up some opportunities.

This may or may not involve shareholder activism to unlock value. I have read reports suggesting that in the US activism may fit in the “too many people are doing it” bucket there, but not so much in other countries.

At the very micro-cap stock level your own experiences with the company’s product, customers, suppliers etc, knowing the shareholder base might be able to give you an edge. The very sophisticated computer research power referred to in this heading would likely be used by larger asset managers that can’t take positions in very small micro-cap stocks.

[5] Value is a Bet Against Technology

The point here is that a value approach will likely be a relative bet against technology in terms of the typical equities’ benchmarks. With some of the higher P/E global tech names getting so large these days most would agree with this.

My thoughts – Firstly as the article points out you could simply adopt similar sector exposures to the major global indices anyway. It doesn’t have to be the case that you are underweight the tech sector. You could apply more of a traditional value approach to the tech sector instead by picking your own tech stocks.

If a value investor’s portfolio does fall out with an underweight tech bet against the index there is certainly no guarantee that is a bad thing going forward. The same fear for value investing strategies was put forward in 1999. Clearly, the internet had a dramatic effect on our lives over the next decade, perhaps even more so than we could imagine at the time. Yet we still saw value investing outperform growth strategies during this time by a big margin.

A lot of the success in growth investing in recent times could be put down to larger tech giants being successful. History shows that it isn’t easy for such giants to stay at the top. Can we as a society spend more time using the likes of YouTube, Facebook, Netflix etc than we are already doing today? I expect that the number of hours per day will stay relatively flat at 24 anyway! Will natural competitive forces or even regulation limit the longer-term growth potential of the major players?

I want to make it clear I am not necessarily predicting their demise or shorting these stocks. I am merely raising the point that going overweight tech is not a sure thing to outperform going forward.

How can value investors respond? – I want to stress I don’t think now is close to resembling the sort of froth in the tech sector resembling that seen prior to the tech bubble bursting in 2000. It is my view though that there is rarely an obvious sector bet in the markets that exist.

One approach to counter this risk though is to look for companies where their exposure to technology may be relatively hidden. Some “old economy” stocks may be quietly building up a transformation story in the tech sector, yet not labeled as such within official sector classifications. Once again such hidden gems are likely to be found outside the major US companies.

Conclusion

I can see some greater strength in the arguments that value investing may continue to struggle this time. For instance, I would be reluctant to bet strongly on basic smart beta value investing strategies in the large-cap US market. Dare I say it, perhaps value investing has died a little there, and it is different this time.

I do however think that many of the arguments made why value investing is dead are not a whole lot different to points raised some 20 years ago. This was prior to a massive outperformance by so-called value investing strategies over the following decade.

As I have written above I think there may be some areas to drift to for value investors just in case the critics are correct with many of these arguments.

To summarise this can mean hunting for value investments in smaller companies and more so outside of the US market. The bad news is it might involve a bit of work.

In terms of some more arguments to favor this approach I just mentioned above, I will add a few links below. The articles further down could indicate there are tailwinds for looking in such areas and that now may not be a bad time to start.

For investing outside of US markets, now might be a reasonable time?

Are active value strategies better off being used across Asia and Europe?

Admittedly these articles are based on fairly limited timeframes but the messages within may still be relevant and provide food for thought.

Active Investing Trumps Passive Funds...in Asia

Active vs Passive How the Debate Stacks Up in Europe ex-UK Equities

Active vs Passive in Emerging Markets

Will small-cap value strategies rebound once market breadth finally improves?

Then again perhaps I am a value investing dinosaur suffering confirmation bias, and the whole game has changed now. It does feel a bit that way right now!

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Comments

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Moon Kil Woong 3 years ago Contributor's comment

Value investing is not dead, but one must take growth prospects into mind. Likewise, quite the contrary, many old value stocks are so popular their prices no longer sport "value" in their price. Thus the argument is better stated, now that value investing has become mainstream is there any real hidden pockets of "value" left? There are, but they are increasingly hard to find and usually revolve around undervalued growth more than undiscovered value.

Remember buffet had this problem before finding good value chasing down people who 's significant others died with a business to rip them off. That's why he got into insurance in the first place. Value investing can be hard. It is getting very hard again because too many people know how to do the basics.

Steve Green 3 years ago Author's comment

Thanks for the thoughtful reply and I agree.

What I would add is I think trying to find that undervalued growth story is only going to get harder going forward. I say that because it seems to me Buffett’s style tilt over the last few decades is what everyone wants to copy cat nowadays. That is buying a wonderful company at a fair price. That usually involves extrapolating some solid growth numbers over the medium to longer term. I typically see that as the marketing angle for most funds management firms. Rarely now do I see them marketing their strategy around say buying “cigar butts”.

The idea that you can find a good company that will grow earnings at a greater rate for 5-10 years than the market thinks seems to me to be an ultra competitive area. Hence multiple expansion and the risk of errors if you aren’t quite up to the talent of Buffett and those that are trying to emulate his more recent style.

That makes sense I think as this is what sells well if your are trying to start up a fund and manage hundreds of millions.

Many individual investors don’t have that problem so perhaps shouldn’t dismiss looking for buying average companies that are dirt cheap. They have the chance liquidity wise to sell them when necessary and move onto the next opportunity as they see fit. That is trickier for Buffett now of course as he manages a tad bit more money than say in the 50s / 60s! I see this area as far less fashionable right now and possibly offers the individual investor greater potential.

It depends a lot on your skill set though. Many are far better than me at identifying the future growth trends and may well do better with a more “growth” style. But as you point out be sure to find the value behind the investment proposition.

Philip Brown 3 years ago Member's comment

Good thoughts.

Leslie Miriam 3 years ago Member's comment

Great read.