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Some Thoughts on Why Value Investing Is Underperforming in 2020

Value and growth have taken different paths this year

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May 07, 2020
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For the past decade, there has been an ongoing debate in the financial community about value investing. Since the aftermath of the financial crisis, value stocks have substantially underperformed growth stocks, despite the latter's rising valuations and the former's cheapening multiples.

Trying to explain why this phenomenon has come into existence is difficult. There is no single correct answer.

One explanation is the idea that value stocks are often companies in declining industries, suffering from falling sales, rising costs and high levels of debt. Growth stocks, on the other hand, are much less likely to be in declining industries.

Many of these growth companies are technology companies at the forefront of the global technology revolution. As such, their revenues may have increased drastically, while other old-style companies have struggled to stay alive.

If you want to use this argument, you could say that struggling companies have been bad investments. Meanwhile, businesses that have a product that consumers actually want have powered ahead. That's one way of looking at it.

This trend is quite apparent in the energy sector. ExxonMobil (

XOM, Financial) used to be the world's largest company, a giant of the oil industry and one of the most profitable businesses on earth, but this has changed over the past few years. The company is now in the doldrums as profit has collapsed and the world moves away from hydrocarbons towards clean energy. The falling oil price has also had a significant impact on the company, but low oil prices and rising levels of renewable energy production go hand in hand.

Value in 2020

The above argument has gained weight in recent weeks. Value investing has always seemed attractive because it tends to outperform throughout the whole cycle, not just bull markets like with growth investing. Historically, the value strategy has tended to outperform in bear markets, usually coming out on top over the full cycle.

However, this hasn't happened yet in 2020. Global value stocks have underperformed global growth stocks since the beginning of the bear market, accoring to my estimations. This is very surprising. Value stocks should outperform in volatile markets as investors seek safety. The fact that growth stocks have been able to achieve such a fantastic performance while value has languished seems outstanding.

Or is it? We need to understand what value investing is before deciding if it has really underperformed growth.

Warren Buffett (Trades, Portfolio) once said that everyone is a value investor because it's the only way of investing. You find a company, place a value on it and buy at a discount to that value.

If we take this example, placing value and growth stocks into different buckets does not make much sense. If you can buy Apple (

AAPL, Financial) at a 20% discount to your estimate of intrinsic value, and you also buy Exxon at a 20% discount, don't they both count as value stocks?

The current crisis has highlighted an issue here, in my opinion. To be able to value a business, you need to have some idea of its future cash flows. With a business like Apple, that's relatively easy. The company has a sticky product, lots of recurring revenue and controls most of the market. But what about Exxon? It has no pricing power, is losing market share and has no recurring revenues.

That may be one explanation as to why "growth stocks" have outperformed "value stocks" this year. In the current environment, many growth stocks have growing and predictable income streams, while many so-called value stocks just don't have that predictability. Buying stock with no visibility of future cash flows isn't value investing; it's speculating.

Disclosure: The author owns no share mentioned.

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