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If you’re an active value investor, or you’re just holding retirement money in a “value” stock mutual fund, well…. It sucks.
You’ve lost about a fifth of your money so far this year, while competing “growth” funds are nearly even stevens. The market losses of 2020 are almost all on the “value” side of the ledger. Big headline growth stocks, like Amazon AMZN, -0.32%, Facebook FB, -0.91%, Netflix NFLX, +0.09% and Google GOOG, -1.29%, are either hitting new highs or nearing them.
And that adds insults to a lot of injury. Value investing has been lagging growth investing since the financial crisis of 2008-9.
Last decade the index of S&P 500 SPX, -0.40% growth stocks VUG, -0.86% beat its value VTV, +0.11% by about 70 full percentage points in total. Ouch.
Value investing is now so out of fashion that Charles de Vaulx, one of the best value investors around, has opened his funds again to new clients. When he launched IVA Worldwide IVWAX, -1.07% and IVA International IVIOX, -0.86% at the end of 2008 he was fighting them off with a stick.
Value and Growth investing are the Montague and Capulets of the stock market. Value investors—to oversimplify — like to buy things that are certain. They buy stocks that are cheap compared with today’s fundamentals: Current cash value, present asset values, current dividends. Where possible they like to buy stocks that are so cheap that things can even go wrong and they’ll get their money back in the end.
That typically means investing in boring but established companies.
Growth investors, on the other hand, are willing to gamble on the uncertainties of the future. They buy what they hope will be the companies of tomorrow, and the day after tomorrow. And they’re willing to pay high—sometimes sky high—prices for the privilege.
You might reasonably argue that companies such as Amazon and Netflix are the companies of today as well as tomorrow, and have terrific fundamentals. But the risk “growth” investors take is that they pay a lot extra for that growth.
Amazon stock currently sells for 112 times last year’s per-share earnings: You’re paying $112 for each dollar of after-tax profit the company made last year. So someone buying Amazon stock here isn’t just betting that Amazon will be great today but that it will be even greater tomorrow.
Meanwhile Verizon Communications VZ, -1.40%, one of the top “value” stocks in the market, sells for just 12 times last year’s earnings, or barely one-tenth as much. Someone buying Verizon isn’t taking a big gamble on future growth. They’re happy with what they own right now. Verizon stock currently pays a 4.5% dividend yield.
The divide between value and growth is an old one. Benjamin Graham is generally thought of as the father of value investing: He got hosed in the crash of ’29, and thereafter made it a rule only to buy stocks that were so cheap compared with fundamentals he had a wide “margin of safety” in case things went wrong.
Philip Fisher, author of the 1950s classic Common Stocks and Uncommon Profits, is among the most famous apostles of growth investing. He argued that the key to making big money was to find great long-term growth companies, buy them and then pretty much hang on forever.
Who is right? Well, both, presumably. It just depends on how much you pay for the stocks. Warren Buffett, notably, says he’s been influenced by both Graham and Fisher (Although his investment company, Berkshire Hathaway BRK.B, +0.19%, is now a big component of the U.S. “value” index.)
The dismal performance of so-called “value” since the financial crisis has produced a new wave of soul-searching among investors and academics.
Finance professors Eugene Fama and Kenneth French, who argued for a long time that value stocks tend to outperform the market over time, recently conceded that value’s long-term superiority seems to have faded dramatically.
Big value stocks beat the overall market index by an average of 0.36 percentage points a month from 1963 to 1991, they calculate. (That works out an average of about 4.4% a year).
But since 1991 that’s collapsed to just 0.05 percentage points a month, they say. (That’s about 0.6% a year). “We don’t reject the hypothesis that out-of-sample expected monthly premiums are zero,” which is how financial professors say that in future, value investing may get you bupkis.
The number crunchers at the Greenwich, Conn., hedge fund company AQR aren’t so sure. They suspect value remains a viable investment strategy, although they think investors need to calculate “value” in more sophisticated ways in the way.
“We think the medium-term odds are now, rather dramatically, on the side of value,” writes AQR honcho Cliff Asness in a blog post. “It has certainly been excruciating getting here, but here we are, and it’s never looked cheaper looking forward.”
Value’s recent woes are nothing new, writes David Blitz, the head of Quantitative Research at money manager Robeco. For value investors the decade just past looks much like the 1990s—another “lost decade” when they were desperately out of fashion. That was followed by a period when the market swung away from growth and back to value.
The chart above is drawn from data published by MSCI, the market information company. It compares the total returns of the U.S. “value” and “growth” indexes during various periods since it began calculating them at the end of 1974. The returns are in so-called “real” terms, meaning they’ve been adjusted to take account of general price inflation.
Maybe this is data mining, but it looks there have been four clear regimes or periods over that time. For 14 years value beat growth into a cocked hat. For the next 11 years it was growth’s turn. During the dismal years on the U.S. market from 2000 to 2006, value stocks eked out a small profit, while growth stocks lost nearly half their real value. And since the end of 2006, growth stocks have boomed again.
What causes these changes? Nobody really knows. Fashion? Changing macroeconomic environments? Interest rates? New technology? Sunspots?
Maybe it’s just price. In early 2000, at the peak of the growth mania, big tech favorite Cisco CSCO, +5.36% was trading for 150 times last year’s earnings. Many established, old-fashioned value companies were trading at less than 10 times earnings. Some reached as low as five times last year’s earnings with dividend yields of 10%. Sheer madness.
No one can be certain if the tide will turn, and if so, when. But the massive relative outperformance of growth over the past year and a half or so looks eerily similar to that in 1998-9.
“Growth’s outperformance will end when it finally crumbles under its own weight, as it finally did in 2000, but I have no idea if it happens next week or in five years,” says veteran value investor Josh Strauss of money manager Pekin Hardy Strauss. Value investing will rise again, he says, but “the reason for the comeback will only be obvious in retrospect.”
