S&P’s Indexology blog posted an article yesterday on value investing in the US, titled “Losing My Religion.”
The gist of the post is that both over the past one- and ten-year periods, value investing strategies have generally, and pretty steadily, underperformed the S&P. The author, Tim Edwards, senior director of index investment strategy for S&P, suggests that this may be because value investing has become too popular. In his words, “With so much energy directed to exploiting the excess returns available through value investing, maybe the only “value” stocks left are the value traps, those stocks whose prices are low as their prospects are determinedly poor.”
my semi-random thoughts
- Value investing has been around at least since the 1930s and is the dominant investment style for professionals worldwide. Growth stock investing may be a close second to value in the US but is a non-starter elsewhere.
- Value investing does not mean buying stocks that are cheap relative to their future prospects, i.e., bargains. Rather, it’s a rule-governed process of buying, depending on the flavor of value an adherent espouses, the stocks with the lowest price to earnings, price to cash flow or price to net assets ratio–on the idea that the market has already factored into prices the worst that can possible happen, and then some. So once the market begins to turn an objective eye toward such stocks once more, their prices will rise. At the same time, downside is limited because the stocks can’t fall off the floor.
- As a dyed-in-the-wool growth stock investor (who has worked side by side with value colleagues for virtually all of his professional career), my observation is that value stock indices routinely include growth stocks. Growth indices, in contrast, are often salted with stocks that are well past their best-by date and that are ticking time bombs no self-respecting growth stock investor would own. Academics use these mischaracterized indices to “prove” the superiority of value over growth. Indexers use similar methodologies. Be that as it may, this is another reason for surprise at the years-long underperformance of value.
- Early in my career I became acquainted with a married couple, where the husband was an excellent growth stock investor, the wife a similarly accomplished value stock picker. She outperformed him in the first two years of a business cycle; he outperformed her in the next two years. Their long-term records were identical. This is how value and growth worked until the late 1990s.
The late 1990s produced a super-long growth cycle that culminated in the Internet bust of 2000. That was followed by a super value cycle that ran most of the next 4-5 years. Both were a break with past patterns. The strength of the second may be a reason value has looked so bad since.
5. Still, what I find surprising about the past decade is the persistent underperformance of value, despite the birth of a post-Great Recession business cycle in 2009. The cycle turn has always been the prime period of value outperformance. Why not now? …the Internet.