"Value investing" has underperformed "growth investing" for the past decade. The difference in performance between the two strategies has only accelerated this year. Following this performance, it's only natural to ask if value investing is dead.
Spread of returns
Before I try and answer this question, I should point out that while it looks as if the S&P 500 has performed relatively well this year despite the economic devastation wreaked by the coronavirus pandemic, only 80 of the 500 stocks in the index are trading at all-time highs.
The rest of the index is trading an average of 25% below all-time highs. Around 100 companies are selling more than 50% below their all-time highs.
So, this is a tale of two markets. There are the high performing stocks, namely technology businesses, which have produced significant outperformance compared to the rest of the market this year. And then there are the other businesses, companies that have been affected by the coronavirus pandemic. Based on their performance compared to tech stocks, it looks as if investors have been staying away from these businesses.
As well as the above, it needs to be noted that we are still in the middle of the coronavirus crisis. So, any conclusions drawn about the performance of different styles today are likely to be misleading.
That said, in the past, the majority of value's outperformance has come from its resilience in bear markets. This has not happened in 2020. Before we try to draw any conclusions from this, we should first ask, what is value investing?
What is value investing?
That's kind of a difficult question to answer, but if we invert the question, it becomes easier. So, what is not value investing?
Warren Buffett (Trades, Portfolio) once described value investing as paying less for something today than you expect it to be worth in the future. By that definition, most of investing is value investing.
What value investing isn't is paying for a shrinking business that's struggling with falling profits, a weak balance sheet and structural problems. Many of the businesses on the market that fall into the traditional value buckets meet these criteria. Low valuations today are more likely to reflect weak growth outlooks and generally poor investor sentiment than they were in the past given how many more investors are in the markets these days.
On the other hand, there's no need to pay an extreme multiple to buy a good quality business. With more than $84 billion in assets as of May 2020, the Vanguard Value Index Fund Admiral Shares Fund is one of the largest and one of the more successful value funds on the market.
The average price-earnings multiple of stocks in the portfolio is over 18, while the average price-book multiple is around 2.2. Many traditional value investors would not consider any businesses trading at these multiples. But with the average earnings growth rate of the portfolio at 7% and the return on equity of 16%, it's clear these businesses are growing, and they meet Buffett's definition of value investing.
The bottom line
Overall, while it is still too early to draw any conclusions about the performance of value vs. growth in this crisis, one thing we have discovered over the past nine months is that buying businesses based on a conservative estimate of what they could be worth in the future does produce returns. That may not be value investing in the most conventional sense, although it is still value investing.
To put it another way, value investing has not fallen by the wayside. However, the style of deep value investing Benjamin Graham pioneered, which was based on information arbitrage, has become less and less relevant over the past few decades as information has become faster and more accessible. Stocks that look dirt-cheap today more often than not deserve to be.
Disclosure: The author owns no share mentioned.
Read more here:
- Illiquidity, Psychology and Charlie Munger
- A Look Back at Warren Buffett's Gen Re Mistake
- Warren Buffett: How to Understand the Foundations of Investing
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