Yesterday I skimmed the short but valuable book The Investment Answer, by Goldie and Murray. The late Mr. Murray was an institutional salesman for a number of brokerage firms; Mr. Goldie is a fee-only investment adviser.
The book, which I think is well worth reading, contains lots of financial planning basics, laid out in clear, simple language. The first chapter, which deals with the traditional registered representative, is particularly good.
The only real quarrel I have with The Investment Answer is the chart it contains which asserts that value investing generates higher returns than growth investing. This is a common belief, reinforced by numerous academic studies which claim to “prove” this.
I think this claim is just wrong.
But I had a long, and relatively successful career as a growth stock investor, so of course I’m going to think this.
Worse than that, however, I suspect that demographic and technological change are undermining the fundamental pillars of the traditional value investing style.
About those studies–
–the typical procedure is for an academic to take a universe of stocks, say the S&P 500, and divide it into two parts. The “value” part will consist of stocks with the lowest price-earnings ratios, lowest price-to-cash-flow ratios and lowest price-to-book-value ratios, all based either on historical data or on consensus Wall Street estimates (in the case future-oriented information is also used). Put another way, these are the cheapest stocks, based on consensus beliefs. The “growth” part will be everything else, meaning all the expensive stocks.
The studies then show that the cheap stocks perform better than the expensive ones. What a surprise!?!
What’s wrong here? It’s the definition of value vs. growth. The studies assume the difference is between two mutually exclusive groups separated from one another using a single set of rules.
The reality is that growth and value are not mutually exclusive. They’re two different ways of looking at the investment world.
The growth investor looks for stocks where he believes the consensus view is mistaken, either by underestimating how fast earnings will grow and/or how long this superior earnings performance will last. A growth investor may hold many stocks that the academic classifies as “value” (think: the AAPL of a few years ago); there are many that the academic classifies as “growth” that no self-respecting growth investor would touch with a ten-foot pole.
Why don’t growth investors kick up a fuss about this academic nonsense? It’s not in their best interest. Why show your trade secrets for everyone to see? That would just make your job harder.
More tomorrow.