Value Investing Might Be Dead?

Recently I bumped into a CNBC article titled Value Investing Might Be Dead.

The article summarized three reasons why value investing might be dead from an analyst report from AB Bernstein.

• The long period of low interest rates is the first culprit to blame for the demise of value investing. The outperformance of value might require higher interest rates, which could be structurally difficult to achieve in the foreseeable future.
• Value investors also got burned by the massive rotation to growth stocks as appetite for fast-growing companies like tech surged. Most important growth assets are intangible which in many cases are not captured in book value and retained earnings, making the usefulness of book value and earnings questionable.
• Technology has disrupted industries in a way that may permanently destroy “moats” that used to exist around certain industries, making mean-reversion less likely to hold.

It’s always intriguing to read an article about the potential demise of your own profession. Sometimes there are solid points in the argument. Sometimes it’s entirely reckless. And sometimes the truth is somewhere in between. In this case, the truth is probably somewhere in between.

The analyst offers a reasonable explanation for the underperformance for “classic value investors” or “conventional value investors" during the past decade. It reminds me of what Charlie Munger (Trades, Portfolio) said in an interview with Becky Quick after this year’s Daily Journal shareholder meeting:

Beck Quick: Do you think the golden era for investing is over?

Charlie Munger (Trades, Portfolio): Not forever. There are times when it’s easier and there are times which are harder. Right now it’s tougher. The valuations have come up so much. And the competition sorting through these opportunities have become more intelligent, more aggressive and more nuanced. Of course it’s harder. The net result is that people will get worse results. The opportunities that we all remember came from a denormalized period in which ninety percent of the natural stock buyers got very discouraged at stocks. That’s what created the opportunity for these fabulous records that my generation had. And that was a rare opportunity that came to a rare group of people of whom I was one. And Warren was another. People who start now have lower opportunity.

No doubt it’s been a tough decade, especially for the U.S. value investors. The question is, “Is value investing dead or it’s just tougher now?”

First of all, the “value investing” style that the AB Bernstein analyst refers to is not “authentic value investing.” Value investing means buying something for less than its intrinsic value. A low price-book ratio says very little about the underlying intrinsic value of the business these days. Buying low price-book stocks with the hope that valuation will reverse to historical mean is not much different from speculation. It shouldn’t work in the long run. In this regard, I think the AB Bernstein analyst may not have captured the essence of value investing and used the wrong proxy in the analysis.

If we define value investing as buying something for less than its intrinsic value, then all the three factors listed by the Bernstein analysts won’t lead us to the conclusion that value investing is dead because they all can be overcome by intelligent analysis:

1. Risk-free interest rate is the starting point of the capital market line. Investors can adjust the risk premium based on different risk-free interest rates.
2. There shouldn’t be categorical differences between growth stocks and value stocks. The intrinsic value of a business captures the growth of the business, regardless of fast growth or slow growth.
3. Moat analysis should be part of every value investor’s research process. It shouldn’t be taken for granted that the moat is intact and mean-reversion will happen.

Value investing is not dead. It’s has just gotten a lot tougher. As Munger shrewdly observed: “The valuations have come up so much. And the competition sorting through these opportunities have become more intelligent, more aggressive and more nuanced. Of course it’s harder. The net result is that people will get worse results.”

Every value investor should accept the fact that it’s a lot tougher now and adapt to the new reality instead of getting trapped in a state of denial and finding excuses. There are a few things we can do to increase the odds of beating the index:

1. Better and deeper research. Very few value investors are known for their deep research. It’s hard to go deep when you have 30 names in a portfolio and you have to keep finding new names that appear to be cheap. Everyone should learn from Thomas Macpherson, who exemplifies deep research by really practicing the scuttlebutt approach in his research.
2. Fewer ideas and more concentration. Again, to quote Munger: “The competition sorting through these opportunities have become more intelligent, more aggressive and more nuanced.” This means that there are fewer opportunities. Investors have to be more selective.
3. Fish in less efficient markets – micro cap stocks, international stocks, special situations, specialized niche areas and so forth. Wherever there is less smart money.
4. To paraphrase Dave Rolfe of Wedgewood –Â be more open-minded and stop categorizing stocks into deep value or growth or GARP, technology companies or traditional businesses.

Conclusion

Value investing, properly defined, is absolutely not dead. The tailwind that has benefited the previous generations of value investors has largely gone and the new generation of value investors may face a tougher time, temporary or prolonged. Aspiring value investors will have to rapidly adapt and evolve to the new and difficult environment to survive.

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Notes From Tony Nicely's Talk, Part 1Â

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