The 'Intellectual Laziness' of Value and Growth Investing

Investors who believe growth and value are not linked could face serious problems

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Jan 06, 2021
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One of the biggest lessons I've learned over the past two or three years is that value and growth are not exclusive. Some investors like to state that they are a value or growth investor, as if being so gives them access to an exclusive club. The truth is that it does not.

Value and growth should not be thought of as distinct investment styles, in my view. They both lean on each other. Buying a stock trading at a deep discount to book value or other value investing considerations is no good if the firm is not growing. At the same time, paying a high multiple for a rapidly growing business can expose one to additional risk and volatility.

Investors and analysts like to use the terms "value" and "growth" because they're easy to talk about, but in reality, bucketing firms into these brackets is far from efficient.

Warren Buffett (Trades, Portfolio) explained this point in his letter to investors of Berkshire Hathaway all the way back in 1992:

"Whether appropriate or not, the term "value investing" is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, a low dividend yield – are in no way inconsistent with a "value" purchase."

What should investors be looking for then? There's no clear answer, but one of the highly successful investors I like to follow, the founder of Nomad Capital Nick Sleep, proposed one solution in a letter to his investors in the mid-2000's:

"Our definition is that a business is worth the free cash flow that it can be expected to generate between now and judgment day, discounted back at a reasonable rate. Period. Growth is therefore inherently part of the value judgment, not a separate discipline."

For some background, Sleep's Nomad returned 18% per annum between 2001 and 2013 when it was shut down. It created $2 billion in profits for its investors during this period.

Sleep went on to question why so many analysts and investors still rely on these metrics if they're so unreliable. The answer, he proposed, was intellectual laziness:

"Their survival [investment ratios] can probably be attributed to intellectual laziness on the part of the investment professional, and spin on the part of the industry's marketing departments. It certainly has little to do with investment excellence. So when commentators suggest that "value" has beaten "growth", or "growth" has beaten "value", please note that little of real substance is being imparted."

This is something that should get far more attention, in my view. Companies cannot and should not be divided into buckets. There's far more to any business than just a simple ratio. Spending too much time focusing on these metrics just because they fit an ideal of the perfect value or growth investment will likely lead to misleading outcomes and poor investment returns.

Some stocks may deserve high valuations because they have sustainable and growing cash flow streams or a unique competitive advantage. No one can tell what makes a business tick by looking at the price-earnings ratio. Further, no one can tell you if a business is really worth its asset value if it is trading at a discount to book. Finding the answers to these questions requires detailed analysis. There are no shortcuts.

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