Are we being too harsh to value investing?
Updated: Jul 3, 2020
In the last few weeks, I have been seeing a lot of videos and articles with titles like “Is Value Investing Dead”. There were so many of these popping up in my feed that if you replaced the phrase "value investing" with a name of a celebrity, I would have just believed it was true. The catalyst for these opinion pieces have definitely been Warren Buffet announcing that he lost over $50 billion in the last quarter. Its never good when the poster boy for your strategy just recorded his highest loss ever. So, I decided to research what all the fuss was about. It seems like this notion that value investing is dead or dying has been around for a while. And it gains momentum every once in a while whenever a crisis emerges.
So what is value investing? Value investing is a strategy of picking stocks to invest in, on the basis that the stock is undervalued. This involves looking at the financials of a company and estimating its book value. The strategy believes that the market has disproportional reactions to positive and negative news and hence there are periods of time when a stock can be undervalued. Hence, picking up these stocks when they are down is considered a bargain as they are expected to go back to their true value after a period of time. This is coupled with the idea that while the market has temporarily lost faith in a company, its fundamentals actually have not changed. The best known proponent of this style of investing is Warren Buffett.
On the other side of the coin, we have growth investing. This strategy targets younger companies with a high growth rate or industries that are expanding rapidly. Investors are willing to pay high prices for these stocks with the intention of selling them at even higher prices as the companies grow faster and faster. Such a strategy targets a much higher rate of return because the idea is to pick the fastest growing stock.
In order to assess which strategy has historically performed better, we can take a look at Russell 3000 Growth and Value indices. In the last 5 years, it appears that the Russell 3000 Value Index (Red line) has consistently been outperformed by the equivalent Growth Index (Blue line). So, there may be some truth to this after all.
Why does it keep dying according to some?
But if growth investing always outperforms value investing, then why do we only bring up this topic during financial crises? So here is my theory.
Under normal circumstances, both these strategies are fuelled by different factors. Value investors would look at fundamentals while growth investors will look at the level of innovation.
However, during a crisis, all these factors are disregarded. During such a time, value investors will buy based on a belief that the stock will go back to its original value. growth investors will buy based on a belief that their young, growing company will survive the crisis.
And hence it is a battle of how many investors you can convince to buy your stock. Therefore, I think during market downturns, value stocks are selectively targeted as “dead” to drive more capital towards the growth stocks.
Growth stocks are by definition supposed to grow while value stocks are expected to retain value. Why then, during financial crises, do we change our metrics when comparing the 2?
Now, there are going to be arguments from both sides as to why after the crisis their strategy will prevail and all these arguments are valid. However, my point is, during the crisis the debate gets more heated in order to channel capital towards their favourite strategy.
I choose to remain balanced and keep a bit of my portfolio in each of these strategies. But I will admit, growth stocks do look more attractive during a market downturn.
Value investing is cyclical
Value stocks are basically companies who have emerged dominant in their industry and have build a successful moat to fend off competition. They are able to maintain a stable market share and hence a fairly stable revenue and profit stream. That is the end goal of all companies. Every growth stock has to slow down at some point and reach this level. And therefore, for safe and consistent returns, value stocks are the way to go.
However, relying solely on value stocks cannot be the answer. Warren Buffett always mentions the concept of moats in his speeches and many of his followers buy it. But the fact remains, a moat can be crossed in seconds if the competitors are clever enough.
Lets take the example of agricultural stocks. The industry leaders have a lot of capital investments in land, factories and machinery such that a new company can never catch up with them. However, when you invent something completely new like plant based meat or lab grown food, it renders any moat built up over the years as irrelevant and threatens the whole industry.
Industries such as manufacturing, agriculture, energy are all being disrupted by new technology right now. All of the defences the incumbents have built up over the years are rendered useless. And therefore right now is the absolute worst time to be holding on to value stocks in these industries. This explains why the sudden popularity of the idea that value investing is dying. Industries are disrupted every few years, and then the fear mongering starts. So value stocks according to me are very cyclical, and you need to ensure that you are also buying at the right time in the cycle.
Teetering growth stocks
I feel that value stocks are an easy target whenever they are underperforming and growth stocks never get the same level of criticism they deserve. There are a lot of growth companies that are in dire situations, and investors have selective memories about the ones that failed.
Take WeWork for example. If growth companies were a box of stationeries, WeWork would be the eraser that claimed that it could erase ink. The company was so ambitious that it wanted to revolutionise the entire office space, residential, school market all at once. Instead of chasing sustainable revenues it was forced to grow faster and faster and it eventually collapsed right before its IPO when the property rental market started to expose its liabilities.
Sure this company never made it to the stock exchanges, but it was extremely close to unloading its useless stocks onto the unsuspecting public. And that is how some growth companies are. They are merely a game of pass the parcel until someone at the end is left holding the useless stocks.
Let’s also take a look at Uber. I know this is a favourite stock of many and the market however, I think this is a growth stock I would never go near. Uber has shown itself to be quite capable and have managed to grow year on year revenue at a considerably high rate. If it was not for the current crisis we are in, many would expect them to have grown even more in the coming years.
However, the current crisis has exposed Uber’s flaw. If the world changes such that more and more people start working from home, then Uber’s disruption of the taxi industry would have been completely futile. It remains to be seen how long this issue will stretch on, but Uber cannot be in a good position right now. It is down 12% since its IPO and while they are constantly innovating, their financials don’t give me much confidence. Questions are already being raised about Uber's ability to sail through this crisis .
So my point is that growth investing has just as many pitfalls as value investing. Selectively choosing data points can certainly show that value investing is “dead”. However, this does not automatically mean that growth investing is any much better. The trick is to find the balance and timing between the two.
Disclaimer: This post should not be interpreted as investment advice as I am not a professional financial consultant. The objective of this blog is to share my experiences with others and receive feedback. I will provide links to my information sources to the best of my abilities, but the reader is responsible for their own due diligence