Value Is Dead, Long Live Value

https://www.osam.com/Commentary/value-is-dead-long-live-value

by drocer88 • 7 years ago

103 66 7 years ago

hogFeast3• 7 years ago

You can't go back and just say "Oh, this period and that period". That is hindsight bias. It is psychologically comforting but provides no guide to the future.

It is particularly foolhardy to place the ending point at 1941. If you didn't know, the period directly after this saw high equity returns because the savings of almost everyone was funnelled by the govt into govt bonds.

If you look at how companies were being priced, it is clear why value outperformed.You had profitable companies with $10 of cash trading for $5. You have companies buying back stock at $10 whilst earning $10. Is this comparable to today?

It is kind of surprising that someone taking the cycle view of history (this is the "hardcore" historian approach) appears to have not looked at any contemporaneous evidence. A theory has been created in hindsight, no evidence from the period has been produced. This is history at its worst, and investment research at its worst. This post should be called: all the things you don't learn in the CFA program.

jdsully2• 7 years ago

Ford is hovering around a 1.0 price/book ratio and has dropped below that as early as 2018.

Value is still out there. Then as now there are many reasons why people won’t pay more at the present time for these stocks.

Hypx2• 7 years ago

Yes, many value stocks are near the price floor, and have almost no room left to drop further. Of course, some of these companies are that cheap because they are basically the walking dead of companies (e.g. Gamestop). But for the companies that do have a future, now is a good time to invest in them.

hogFeast3• 7 years ago

If you are measuring value with price/book, you have no hope. The conceit of the "value factor" is wrong-headed: trying to measure value quantitatively is like trying to measure the aesthetic appeal of art quantitatively. It just makes no sense. Quant screens turn up the most uninvestable garbage. The only people who invest that way, haven't ever looked properly at the companies they are investing in (I use value quant screens for shorts now, the flow of money into quant means they are usually comically overpriced).

More to the point though: value is only determined in hindsight. A company trading on 30x earnings can be cheap. The only "value factor" that is closely correlated to returns is 5yr forward earnings. If you think a computer can predict earnings five years forward...great, but they can't.

Also, if you aren't managing $10bn+ you shouldn't be looking at Ford. Don't make it difficult.

robocat2• 7 years ago

I think "Value" is virtually meaningless in modern businesses.

In the past some businesses perhaps depended strongly on capital (e.g. machinery plus cash).

Most modern businesses are simply not dependent on the value of hard capital goods, they depend on the value of their services. The book value of large businesses often contains so many instruments or contracts marked to market, that the book value is largely dependent on market value in disguise.

Examples: TSMC, ARM, a local restaurant, PWC, etc.

Perhaps an exception is real estate companies?

UncleEntity• 7 years ago

It is particularly foolhardy to place the ending point at 1941.

Seems a perfectly logical point since after that the gov't took control of the economy to fuel the war effort and dictated what was produced.

Also, how may Axis citizens saw high equity returns on their government bonds?

hogFeast3• 7 years ago

It isn't a "perfectly logical point" as I have explained. The study looks at technology, not war (as you are suggesting). It is probably the year in the whole of the century that, in hindsight, explains value returns best...is that coincidental choice? I am not sure what your point is about the Axis either...as with the US and the UK, most people had their savings inflated away.

To be totally clear, and this isn't 100% related with the topic: that period is a terrible example because it is reproducible. The assumption with all these studies of long-term returns is that past returns are reproducible. They are not. If you were a normal citizen around 1941, you were forced to invest in govt bonds (banks were forced to buy govt bonds, if you had a deposit you owned govt bonds).

justin66• 7 years ago

If you look at how companies were being priced, it is clear why value outperformed.

You ought to write a paper. Eugene Fama and Kenneth French have always been pretty upfront about not understanding why value outperforms.

sytelus• 7 years ago

You buy stock so you can sell at some future date to convert it into cash. This means you must estimate future value of the stock. The value investing as it gets touted implies that you buy stock given its current value. This is incompatible to the goal of selling stock in future because current value may decline to any arbitrary value. Ford may sell at 1.0 price/book today but it is likely they may to load up on debt down the line OR the value of their assets has lower future value.

So value investing doesn't mean great investing as much as several people wants us to believe. Every stock purchase is necessarily a speculation and there is no escape from that.

jandrewrogers4• 7 years ago

This overlooks the longterm impact of a new type of company that has been greatly enabled by technology: predatory revenue omnivores. These are companies that have figured out how to identify large revenue flows outside their current business or sector and systematically capture that revenue successfully, over and over (Amazon is a good example). In the past, revenue growth was not sector-agnostic in this way because sector expertise created insurmountable advantages for incumbents such that revenue growth was more a function of sector growth and competition came from within that sector. Attempts to materially expand outside a company's native sector almost always ended in failure. Now it looks like a repeatable business model that a minority of companies have figured out.

More and more, you see alien companies successfully colonizing established sectors and stripping them of their revenue. Few value companies are prepared to handle the scenario when these alien companies show up because historically it has never been a realistic threat. I've seen this play out across several industrial sectors over the last decade and almost without exception, companies retreat to niches that the predator hasn't turned its eyes to yet. That's a strategy for being eaten last. The threat is so far outside their experience that they struggle to see a path forward.

If I was going to invest in "value" these days, I'd invest in the revenue predators. They are going to capture much of the best value revenue eventually but this will give them the appearance of "growth" companies in the short term due to the scale of organic revenue growth this business model creates for them.

paulryanrogers• 7 years ago

Who are these predators? Among FAANG I'd guess only the acquisition of YouTube has been a success, and only modest at best.

akkartik• 7 years ago

I don't think GP is referring to acquisitions. Acquisitions signal failures of predation. Predation here = putting incumbents out of business. Quickly ramping up to competitiveness in a whole new sector.

An extreme case of "software eating the world," basically.

tiredyam• 7 years ago

Instagram? Twitch? WhatsApp? Github? I know there are more

jandrewrogers4• 7 years ago

A hallmark of the predators is that they often enter markets without doing any material acquisitions within that sector. They capture revenue organically. This has been reduced to a repeatable system.

That is what makes them so difficult to defend against. They don't behave like market incumbents and they compete with a very different set of skills than are seen in the markets they enter. They also tend to narrowly target the most profitable parts of the sector first instead of the entire value chain and expand from there, which rapidly reduces the profit incumbents could use to invest in a defense.

And in fairness, a lot of sectors are gravy trains for the incumbents. They haven't had to work hard for profits, never mind survival, in a very long time. They also spend the first few years in a state of total denial about the threat when one of these companies shows up.

TimTheTinker2• 7 years ago

Let’s see...

- Apple, Samsung, LG, and Google have supplanted a wide range of consumer products with modern cell phones. Point-and-shoot cameras, some prosumer cameras, low-end document scanners, household telephones, PDAs, small flashlights, small voice recorders, portable tape and CD players, car CD players (via wired or BT connectivity), portable DVD players, boom boxes (via Bluetooth speakers), car GPS navigation systems, compasses (to some extent), pocket notebooks, planners (to some extent), a large segment of the wristwatch and pocket watch market, pocket calculators, professional scientific and graphing calculators, walkie-talkies and handheld radios (not completely though), portable electronic games and some game consoles... those are a few of the big ones.

- There is no type of brick-and-mortar store in any branch of retail or auction that hasn’t been hit hard by Amazon and eBay. Additionally, all the B2B businesses in the retail supply/service chain have been hit hard as either their clients suffer or they themselves lose business to Amazon.

I could go on. The world is a completely different place than what it was 20 years ago.

pjc50• 7 years ago

Google has successfully predated most of the traditional publishing and news industry; Netflix has predated film and TV while not quite having the characteristics of either.

skybrian3• 7 years ago

It seems like you could instead make an argument that Amazon is just sticking with things they're good at. (Various forms of retail sales, along with cloud computing.) They are not a conglomerate combining unrelated businesses like GE or Berkshire Hathaway.

Lots of expansion within the realms they're in, though.

_0ffh• 7 years ago

Amazon is just sticking with things they're good at
They are not a conglomerate combining unrelated businesses

But they don't and they are. Amazon is monitoring sales of all categories of articles, identifies items that sell well and are easy to knock off, then knocks them off. They held more than 70 private brands in April 2018.

[1] https://www.vox.com/2018/4/7/17208804/amazon-private-label-b...

jandrewrogers4• 7 years ago

This is a superficial view of Amazon's business. They increasingly own the upstream manufacturing and production businesses that companies use to produce their products that are then sold retail on Amazon or elsewhere. Amazon isn't just a retailer, they are the supply chain.

Because Amazon is such a powerful force in retail, for businesses that sell on Amazon using Amazon's supply chain to also manufacture their product is the path of least effort. Amazon may not be the cheapest or the best supply chain possible but it is reliable, consistent, and their customer service is good if there is a production problem. Being "hassle-free" is a compelling selling point for many companies, completely independent of the retail considerations.

AWS can be viewed as just a particularly large instance of this but Amazon has been building traditional manufacturing supply chains for their retail vendors for a long time.

kgwgk11• 7 years ago

will give them the appearance of "growth" companies in the short term due to the scale of organic revenue growth this business model creates for them

That’s not the “appearance” of growth, that seems the definition of growth! I also find your reference to “value revenue” somewhat confusing in the context of the usual growth/value classification of stocks.

TimTheTinker2• 7 years ago

I think OP meant “growth” as a category or type of company (as opposed to value companies).

kgwgk11• 7 years ago

Related: "VALUE INVESTING: BRUISED BY 1000 CUTS"

https://www.gmo.com/americas/research-library/value-investin...

Direct link to PDF: https://www.gmo.com/globalassets/articles/insights/asset-all...

anonu• 7 years ago

Very well written article from a reputable firm.

Patrick O'Shag's podcast is pretty good too: http://investorfieldguide.com/podcast/

One should not underestimate the role of regulation in how the Age of Technology plays out.

Yes. The US government needs to step in and enhance privacy and the right to be forgotten... following in the footsteps of our EU brothers.

whatshisface2• 7 years ago

Why would anyone think that value investing could ever work? Everyone can easily see the value of a company, because that's a statement about the present, not the future. It's guaranteed to be already priced in when you buy. You will definitely not be the first person to show up after a quarterly is released.

kgwgk11• 7 years ago

However it has worked quite well for most of the past century: https://i0.wp.com/thetechieinvestor.com/wp-content/uploads/2...

Danieru• 7 years ago

Economists would argue that it is impossible to pickup a $20 from the ground. After all if it was truly a free $20 sitting on the ground then someone else must already picked it up. Thus any $20 sitting on the ground you see must instead be trap.

Part of my growing up has been to realize that sometimes that person picking up the $20 can be yourself. That perfect competition is a theory, and that the world is in fact always far away from that theory. Businesses can survive despite large in-perfections.

Trying to apply efficient market thesis to justify ignoring fundamentals while implicitly claiming growth is not efficiently priced is itself silly. To assume growth is being under priced during an era when all the hype and public attention goes to growth companies is silly.

Boring companies with strong fundamentals and good prices are the vehicles which will preserve wealth and return it to shareholders year in year out. The silly pumps into silly growth companies is the exact behavior marking the end times of a boom cycle.

tryptophan• 7 years ago

Its a risk-based idea. These companies are valued lower (which everyone sees) because they are thought to be riskier. Theoretically, because less people invest in them because of this, it should result in higher returns for those who stick with the value companies due to the higher risk they are taking on.

kgwgk11• 7 years ago

The reasoning often goes the other way, academics find a "factor" that outperforms empirically and try to come up with a risk-based explanation backing theoretically what does happen :-)

An alternative explanation is that they are simply mispriced.

mruts7• 7 years ago

There are two rational justification for the (seemingly) persistent value factor:

1. It’s just a risk premium. The efficient market hypothesis says that all risk adjusted returns are the same. i.e there is only one Sharpe ratio. Or put another way, there is no excess return without commensurate risk. Using this model, value out performs because of the increased riskiness of the investment. Reward for bearing risk is absolutely persistent so if this first reason is true, it should be persistent forever.

2. Behavioral bias. If this is true, people will wise up and the eventual equilibrium will price value fairly at some point.

Either way, value shouldn’t be able to juice your Sharpe ratio forever. Either the first one is true and the Sharpe ratio is unaffected (just the mean returns, which don’t really matter unless you are unable to access leverage), or value is in fact not persistent, because no behavioral bias can ever be persistent, a priori.

I’m not sure what the answer is, but value alone isn’t worth very much. AQR and other funds usually pair it with factors that have a negative correlation, such as momentum. This allows them to capture significant excess returns, compared to value alone.

kgwgk11• 7 years ago

no behavioral bias can ever be persistent, a priori

Of course it can. Tripping twice over the same stone, etc.

Casinos are full of people playing games with negative expected return after all. And if the stock market is like gambling, it’s mostly on the side of “glamour” (as opposed to “boring”) stocks.

mruts7• 7 years ago

Well, you would expect the markets to reward the people who didn't have these biases, and hurt the people who still had them. The people with the bias will get poorer and poorer, and the people without it will get richer and richer. Those who get poorer and poorer will increasingly have less influence on the world economy, and those getting richer and richer will have out-sized influence.

Eventually, the pool of suckers will disappear and the market will move onto some other bias to stamp out. You can see this very thing happening in capital markets. I work as a quant and many very simple strategies like value, momentum, quality, etc used to work remarkably well, just 15-40 years ago. Nowadays, you need more sophisticated factors, or combine these simple factors together in unique and interesting ways.

There might be a sucker born every minute, but the sucker will never accumulate enough capital for anyone to ever care about him.

whatshisface2• 7 years ago

I'll toss in a third:

3) A rational actor with $1 to their name can't eliminate mispricings because it takes more money than that to move prices. Just because you aren't the first person to show up with knowledge of a mispricing doesn't mean that it has been completely eliminated by the time you get there - those genius hedgefund managers that no mortal can beat may not have enough capital to price every stock in the entire market at exactly what they think it should be.

unless you are unable to access leverage

It's also worth mentioning that you have to pay for loans. "Organic" risk that comes from buying risky securities doesn't have interest, while "synthetic" risk does.

RickJWagner• 7 years ago

Value has taken a beating for over a decade, and predictably there are pundits crawling out of the woodwork explaining how Warren Buffet's day is long past.

I imagine after the next economic cycle Buffet will again be lauded as a genius.

H8crilA5• 7 years ago

He's kind of a closet indexer these days:

https://www.portfoliovisualizer.com/backtest-portfolio?s=y&t...

dade_2• 7 years ago

Benjamin Graham was the genius...

im3w1l• 7 years ago

As of June 30, 2019, the Russell 1000 Value has underperformed the Russell 1000 Growth by a cumulative -136%,

This is some pretty fishy math right here

H8crilA5• 7 years ago

It depends on whether you divide the larger by the smaller, or vice versa. Say X went from 100 to 50, while Y went from 100 to 100. It can be seen as 50% reduction in X's value or 100% underperformance vs Y.

The 100% number is kind of more useful because it is the extra return on the decision to switch to Y back then.

H8crilA5• 7 years ago

When it comes to value one thing that bugs me is the premium one has to pay for American equities. Like I get it, it's a good market, but it is consistently 30% to 100% more expensive across various metrics. American equities can't be this good.

CAPE is a good case in point here: https://mebfaber.com/wp-content/uploads/2019/01/capeys.jpg

SubiculumCode2• 7 years ago

For someone that is not an investor, would someone please explain the difference between growth and value stocks?

My initial guess is that value stocks are underpriced, while growth stocks are priced correctly for current value, but has significant growth potential How close is that?

H8crilA5• 7 years ago

Value investing: you try to come up with an intrinsic valuation of a security and buy if market price is, say, 60% or lower of that valuation. Famous examples: Benjamin Graham, Warren Buffet, Michael Burry.

Growth investing: buy whatever grows (earnings, revenue, even DAU are all flavors of growth investing). VC investing/startup investing is classic growth investing. PG on the topic: http://www.paulgraham.com/growth.html

Growth stocks are usually overpriced because of hype (looking through rose glasses), but can still be good, as the last 10 years shows.

H8crilA5• 7 years ago

Just to throw some data into the mix: the biggest difference is not between growth or value. It's between US and ex-US equities:

https://www.portfoliovisualizer.com/backtest-asset-class-all...

mruts7• 7 years ago

Yeah that's a pretty good guess. Growth generally means a company is expensive relative to it's earnings, profits, or book value. Ratios like P/E (price to earnings), and P/B (price to book) can be used to identify/classify a growth company. Higher these ratios, the higher the stocks exposure to "growth".

A value company is the exact opposite, a stock with low ratios. As you might have suspected, value has been clobbered in the last 10 years, and a bunch of Chicago school economists are pissing their pants (Fama, French, etc).

SubiculumCode2• 7 years ago

Could it be that we are better these days at more accurate valuation? (e.g. better analytics?)

dade_2• 7 years ago

Neither P/E or Book value are useful metrics for value investing. Please read security analysis...

kgwgk11• 7 years ago

https://www.msci.com/documents/1296102/1339060/Factor+Factsh...

"The foundation of value investing is the notion that cheaply priced stocks outperform pricier stocks in the long term."

"Value has several dimensions: the stock price as a multiple of company earnings, price as a multiple of dividends paid, price as a multiple of book value, and other such “ratio descriptors.”

The idea is that investors in aggregate are too optimistic about the stocks with positive outlook (everybody wants them, they get overvalued) and too pesimistic about the stocks with negative outlook (nobody wants them, they get undervalued). In principle, by investing on the stocks that are currently "cheap" (and undervalued in average) you get better returns as they won't do (in average) as bad as discounted by their stock price.

What I described above is the "value factor" (used to classify stocks in the value/growth axis). You can also do "value investing" looking at the fundamentals for a company and making sure that that particular company is undervalued. The factor approach is a systematic way to do that without a detailed analysis for each company: you try to identify the measures that allow you to capture undervalued stocks in average.

chrmeredith23• 7 years ago

SubuculumCode4,

the way I think of this is that the price of any stock is related to the value of its expected future earnings. For value stocks, the bulk of that value is in the near term earnings. For growth, the value is in the long term earnings.

The reason that value stocks outperforms growth stocks in the long term is that people think the distress on value is worse than it is, and overestimate how good it will be for a growth stock.

The reason this is different for now, and in 1926-41, is that the growth stocks executed their business model. And value stocks didn’t revert back from distress.

Hope this helps, Chris

karmakaze• 7 years ago

OT: Is FAANG now used to refer to FAAMA (MS, Alphabet)? I never understood why Netflix was in there with such a small comparative market cap.

Ericson2314• 7 years ago

Maybe much of the US economy is pointless jobs and pointless economic activity, but the system is viscous enough that the inequilibrium isn't readily apparent.

Value Is Dead, Long Live Value

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