Attacking value investing and claiming that the style of investing is "dead" has become quite popular over the past decade. Critics' voices became even louder last year when so-called growth stocks roared higher as the bull market continued despite the Covid-19 pandemic.
This kind of argument is entirely pointless, in my opinion. Value investing is not dead, and growth investing is not a better strategy. To explain this point, I need to highlight the common misunderstanding that value investing is all about buying stocks that look cheap, and growth investing involves buying expensive stocks.
A common misunderstanding
Like so many things in investing, the above is an oversimplified viewpoint. There's no set formula or ratio one can use to find undervalued securities, and there's no shortcut for research. Therefore, trying to bucket stocks into value and growth based on simple metrics is misleading.
The key term here is undervalued securities. Benjamin Graham once described investing as an "operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
Every investor wants to make money. The only way to do this is to buy an asset that's going to increase in value. And the only way to buy an asset that's going to increase in value is to buy something that's going to be worth more in the future than today.
This is the essence of investing. Even so-called growth investors are looking for stocks that could be worth more in the future. They try and work out how fast a company's profits could grow, back these numbers into a valuation, and then buy at a discount to this valuation.
Let's take ARK Invest's model for Tesla (TSLA, Financial) as an example. Last year, ARK estimated that in 2024 Tesla's share price would hit $1,400, adjusted for its five for one stock split. Based on its new research, the firm estimates that it could approach $3,000 in 2025.
How the analysts got to this figure is irrelevant. The point is, the firm was buying the stock at a discount to its estimate of intrinsic value. This is no different from Warren Buffett (Trades, Portfolio)'s acquisition of Coca-Cola (KO, Financial) in the mid-1980s or his Apple (AAPL, Financial) purchases. He was buying these stocks for less than they were worth even though they would have appeared expensive on simplistic models using the price-book or price-earnings ratios.
Overall, all investors should be seeking to buy stocks at a discount to their intrinsic worth. Buying investments without understanding how valuation works is not investing. It's speculation.
Producing the right outcome
Rather than arguing if value or growth investing is dead, investors should instead be asking which valuation methods produce better outcomes.
Assuming all investing is based on the principle of buying assets at a discount to their intrinsic value, then what investors should really be focusing on is the method used to arrive at the estimate of intrinsic value.
There is clear evidence that shows some methods are more reliable than others, in my opinion. Free cash flow generation is a good example. However, the appropriate valuation methods will always vary widely from company to company.
So, rather than arguing which style is better, investors should instead spend more time looking at their own analysis process. After all, how can one claim that value is dead if one does not understand the process used to arrive at that conclusion?
The bottom line
Buying a stock at a discount to its future intrinsic value has always been and will continue to be a profitable strategy.
However, it all depends on the figures and process used to arrive at the target. A price target derived from conservative figures based on detailed research is more reliable than one based on optimistic, speculative numbers.
Investors should ignore the simplistic value and growth buckets and focus on this process instead.
Disclosure: the author owns no share mentioned.
Read more here:
- Warren Buffett and IBM: A Very Profitable Learning Experience
- Berkshire Hathaway and Van Tuyl: What Makes a Good Business
- A Look at the Legendary Sequoia Fund's Top Investment Holdings
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