Is Value Investing Really Dying?
In 2017, traditional value investing has suffered some of the most eye-raising attacks in recent memory.
It started in June, when Goldman Sachs published a widely circulated report showing that following the value approach espoused famously by Fama and French returned a cumulative LOSS of 15% over the past decade. That is a remarkably bad performance in a climate where the S&P 500 has doubled.
This was followed up in October, when notable value-based hedge fund manager David Einhorn (in a note to Greenlight Capital clients) flat-out said he was having "questions regarding whether value investing is a viable strategy". Einhorn and Greenlight are highly respected in the investment world. Nevertheless, his fund is under-performing the S&P 500 by over 11% in 2017, after trailing the market by 3% in 2016 and posting a horrid 2015, with losses of 20% vs. the market's 1.4% gain.
Anecdotally, our experience in pure value strategies has not been particularly impressive, either. We followed Joel Greenblatt's straight value Magic Formula screen "universe" exclusively for 8 years, with a cumulative performance roughly in line with the S&P 500's. In the 2 years since, our two value-based ranked screens ("spells") have underperformed the market by pretty substantial margins, while our growth-based screen has beaten the market by nearly 11% to date.
So what is going on? Is old school value investing really dying? Or are we in an unusual trough for the strategy, that will likely turn around and prove value as the "winning" investment philosophy once again?
Why Is Value Losing?
Both Einhorn and media mogul John Malone have focused the blame on one culprit: Amazon.com (AMZN).
To say Amazon has disrupted not just retail, but the business world at large is an understatement. And now, these prominent investors believe it is disrupting investment modeling itself.
Certainly, Amazon, or Tesla (TSLA) (which Einhorn also fingers), or Netflix (NFLX) cannot be considered attractive investments from a quantitative, value-based perspective. All 3 have minimal or negative GAAP earnings. Only Amazon even generates positive cash flow. And yet those 3 stocks are up 371%, 882%, and 1,577% respectively over the past 5 years. Try to get that from a value strategy!
What's going on? If you asked value-based investors, a few explanations arise. The first is that value is just out of favor vs. growth stocks, and that the climate will revert to the mean - that is, value will once again outperform - in the near future. The second is that we are in a stock valuation "bubble", where investors expectations for continued growth will prove over-estimated, and the resulting fall in high-flying growth stocks will lead value-based approaches to again outperform.
So, will value investing turn the corner and start outperforming again - as it has historically?
The Value Mirage?
Here's something to consider: have quantitative value-based strategies, like those espoused by Fama and French, REALLY outperformed the market so substantially in a normal investing lifetime (e.g. 20-30 years)?
The fact is, the Fama and French model's cumulative out-performance is really due to one 20-year period from the mid-1960's to the mid-1980's. From the 1920's up until then, this strategy had largely trailed the market. And from 1984 until the present, it *has* trailed the market.
The Fama and French, numbers-based value investing method had one remarkable run during a 20 year period of high inflation and low growth. In more progressive business climates such as post-WWII and the ongoing "information age" - essentially, 70 of the last 90 years - it did NOT outperform the market.
Now, I don't necessarily believe this invalidates mechanical value strategies altogether. But it is something to consider and worthwhile to ask about the conventional wisdom around numbers-based value investing.
A Different Approach
Despite the failure of the Fama and French value model to outperform the S&P since the Reagan administration, the fact is that many investors who are considered value-focused, like Warren Buffett of Berkshire Hathaway, HAVE beaten the S&P in that time frame. Maybe that's an understatement... Buffett has outperformed the market by over 7,000% in that period!
That's because these great investors are not buried in the numbers. They don't use just profit margins or valuation ratios or numbers-based screens to determine their investment decisions.
They focus on the BUSINESSES underlying the stocks. If those businesses have great long term prospects for growth, and can fend off competitors over the long term, AND are reasonably valued based on realistic estimations of their future revenue growth, profitability, and cash flow generation - THAT is where great investments are found.
Value or growth, fundamental or technical, in favor or out of favor... all this pales in comparison.
If you can identify a great business for the long term, buy it at a reasonable valuation, and then hold on to it as long as it retains those characteristics - that is where great investment returns are found. That is how you earn 100, 200, even 1,000% on a single investment over a time frame that will allow you to enjoy that money before retirement. If you look at the Forbes 100 list, nearly EVERY SINGLE PERSON is in there because they owned a great business (or businesses), and held on for the long term while those businesses used their growth potential, captive revenues, and competitive advantages to compound returns time and time again.
Really, the only difference between owning Amazon stock and being (richest man in the world) Jeff Bezos is how much you own.
So, to answer the question "Is Value Investing Really Dying?", our response is "who cares?".
Let's focus on what's important - the business - and the stock returns will follow.
This is what we are doing with Business Model Diligence. So far, the "green" rated companies - the BEST businesses - have outperformed the "yellow" ones, while the "red" ones have generated substantially NEGATIVE returns. We expect this to continue and, indeed, the gap to widen over the years. Come join us today and start focusing on the business to build your investing wealth.