This guest post on Value Investing 2018 was written by Net Net Hunter member Jonas Åström. Jonas is a private investor from Stockholm, Sweden. Article image (creative commons) by UggBoy♥UggGirl, edited by Broken Leg Investing.
Value investing, as measured by the traditional value metrics such as price-per-book (P/B), has underperformed growth indexes over the last 10 years in the US and many other countries. Does this mean value investing is dead? There are more and more voices claiming that yes, value investing in 2018 is dead and a bad strategy. I believe those voices to be wrong, and I’ll explain why.
The strikes against value investing 2018
The last 10 years haven’t been good to value indexes such as Russell’s value index or Fama French value factor. Both indexes compare value companies with growth companies, and value had long-term been the winner — until around 2008-2009. Since then, growth has outperformed value by quite a lot. Value is defined as low P/B and low PE ratios, while growth has been defined as the opposite.
Some people question whether traditional value metrics are still relevant in valuing companies. They are certainly right — intellectual properties are often much more valuable than old machinery. Take Facebook as an example — the value it has created exploiting the network effect and the addiction people have for its product is not reflected on Facebook’s balance sheet. Another example is a service-oriented company that needs neither lots of working capital nor expensive machinery. Its value lies in how it can monetize its workforce’s skills and business model. You don’t see that in the book value calculation.
In addition, lots of companies are buying back stock very aggressively, and that will reduce their book value in cases where they repurchase above book value — thus destroying book value.
Even famous hedge fund managers such as David Einhorn, who sees himself as a value investor, are questioning the old principles of value investing:
The market remains very challenging for Value investing strategies, as growth stocks have continued to outperform value stocks. The persistence of this dynamic leads to questions regarding whether value investing is a viable strategy,
The value investing landscape is definitely different in 2018 compared to the history.
Why value investing in 2018 still makes sense
If P/B is a bad metric and doesn’t capture the real value of a contemporary business, then that must mean that the comparison between growth and value indexes is incorrect. So, does this mean that value investing is alive despite negative media coverage. Or what does it really mean?
I’ve seen investors arguing to make more and more complicated and subjective “adjustments” to the book value calculation. Normally, they add in more Intellectual Property to reflect a “moat,” and they add back depreciation of fixed assets such as buildings and land. Maybe such adjustments would make the Russell 1000’s value index look better, and maybe an updated definition of value would have performed better.
The current bull market and the outperformance of growth stocks is definitely making people question the concept of value investing. FOMO is the problem: Fear Of Missing Out. When people get jealous of other people crushing the indexes, they change investment strategies and hope for the best. If there is one thing that is for sure in investing, it is that a lack of consistency in one’s investment strategy is terrible for the investment’s performance. All strategies underperform for periods, and when the period is over, that strategy will recover — and that holds true to value investing as well.
Stick with value investing in 2018 despite temptation to abandon the strategy
With a current (May 22, 2018) Shiller PE of 30 compared to the mean value of 16.9 (3.3% expected return) and with a P/E ratio of 22 compared to mean of 16, we are definitely at high valuations. The Fed’s manipulation of interest rates has made the market set new all-time highs seemingly on a weekly basis.
During times of long bull markets and all-time highs with very stretched valuations, as we’re seeing today, it is really hard to be a value investor. FOMO has made lots of value investors adopt momentum investing based on the greater fool theory. There is so little “traditional” value to find in the US stock market today that people are grasping after anything that can justify the value. It is very hard to underperform the massive returns that some growth stocks have had in the long term. It is sad to see how big “value podcasts” spend much more time analyzing what the Fed will do at its next meeting or whether it is best to use a 200-day moving average or a 100-day average.
Don’t make the same mistake. All strategies underperform from time to time, but eventually they recover. This has happened before to Value investing, and it will happen again. If you go back to the period of 1997-2000, you can see that growth outperformed value massively. The market was crazy for everything that looked internet-ish. Warren Buffett was ridiculed during the dot-com bubble, but he didn’t let that affect his investment strategy — and he got his revenge when the market crashed by realizing hefty profits.
There is so much noise and speculation out there in the media and social media today. You need to learn to ignore it. Various strategies are promoted with promises to outperform massively, but the truth is that few investment strategies have been backtested so thoroughly and extensively as value investing. The result is clear — value investing does outperform in the long run. Tune out the noise and focus on true value. It really doesn’t matter if you implement a low P/B, low PE or negative EV model — it will all work out because buying a stock for less than what it is worth is the best strategy.
Don’t let the latest hiccup in the value indexes affect your investment strategy. Stick to your chosen value strategy, and you will outperform in the long run. That is what matters the most.
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