Key Takeaways
• While growth has outperformed value significantly since the global financial crisis, the two styles have traded leadership in recent decades and value has dominated over the long term.
• The ongoing structural shift toward a knowledge-based economy heavily reliant on intangible assets—which, for the most part, are not captured in current financial accounting standards—has presented a challenge to investors seeking to identify undervalued stocks.
• With the rise of intangible assets, traditional metrics like book value seem to have become increasingly unmoored from the intrinsic value of many businesses, exacerbating flaws inherent in purely statistical approaches to value investing and index composition.
• By first defining the fundamental character of a business— the tangible and intangible assets from which value is derived—before attempting to attach a price to its stock, First Eagle seeks to uncover attractive businesses selling at a discount to our estimate of their intrinsic value and to selectively construct portfolios offering an investment experience differentiated from that of statistical value managers and indexes.
The performance of value strategies in recent years has led some to question whether the traditional signals of underpriced stocks remain a reliable source of long-term excess returns, as they have since emerging in the wake of the Great Depression. Ongoing structural changes in the economy may be at least partially to blame for the modern underperformance, as the knowledge-based businesses emblematic of the new economy increasingly are focused on the development of intangible assets rather than the property, plant and equipment investments that were the hallmarks of the old guard. Current financial accounting standards fail to capture the bulk of these intangible assets, however, thus understating the true value of many businesses and distorting the valuation ratios often relied on to identify mispriced stocks.
This is not to say that value opportunities, when identified, do not have the potential to offer attractive longterm returns. However, it does highlight the importance of distinguishing between "statistical value" strategies as applied by quantitative investment managers and the fundamental efforts to identify asymmetries between price and intrinsic value pioneered by Ben Graham and further developed by the likes of Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio). While quantitative investors may find their methods compromised by the limited availability of comprehensive datasets on intangible assets, fundamental, research-driven managers able to capture the full range of tangible and intangible factors that drive business performance may be well positioned for a potential return to long-term growth/ value norms.
Recent Growth Dominance Obscures Long-Term Trends
The outperformance of growth stocks in the decade-plus following the global financial crisis has been well documented, and the contrast has become only more pronounced over the past year, driven in part by dynamics that emerged in the wake of the pandemic-related disruptions of first quarter 2020. As shown in Exhibit 1, the MSCI World Index has compounded at an annualized rate of 9.4% over the past decade, with the MSCI World Growth Index climbing 12.6% compared to the 6.0% increase in the MSCI World Value Index, a meaningful dispersion but within the historical norms of cyclical variation. More recent relative performance appears far less typical, however. For the 12 months ended September 30, 2020, the MSCI World Index was up 10.4%, with the growth component returning 30.5% compared to an 8.4% decline in value; this spread of nearly 39% almost defies belief given that the growth and value indexes have a long-term historical correlation in excess of 0.9. Performance differentials are even more pronounced in the US, perhaps not surprising given the dominance of very large US-based growth stocks in recent years.
Given the lengthy and ongoing divergence between growth and value, it can be easy to forget that these investment styles have traded leadership in recent decades. The most recent period of extended value outperformance came with the collapse of the dot-com bubble in 2000 and persisted until the extraordinary policy response to the global financial crisis flooded the system with liquidity and boosted appetites for future cash flows in a low-discount-rate world. Referring to Exhibit 1, the 25-year annualized performance of growth and value is much closer than recent trends would seem to suggest. Taking an even longer look back, as in Exhibit 2, value's performance has outpaced growth more often than not since the Great Depression.
Defining Value Across the Years
Of course, methods for identifying undervalued businesses and for building portfolios designed to leverage apparent mispricings in the markets to generate above-market investment returns has evolved since the depths of the Great Depression, though perhaps less than one might expect.
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