Accretive On: The Death of Value Investing

February 19, 2020

Is Value Investing dead?

There has been a lot of discussion lately on the recent relative ineffectiveness of value investing.  This has practitioners questioning a lot of previously indisputable (to many) investment truths.  Last time this happened, in the late 90’s, many questioned whether Warren Buffett had lost touch and many of the best value investors decided to call it quits.  This time around it is Eugene Fama and Kenneth French, the former of whom recently won a Nobel prize for his prior work on markets, who are questioning their own premises.  Their conclusion, based on their most recent research, is that they can no longer say for sure whether or not the “Value Premium” exists.  Here we break down Value Investing and share our take on if it is dead.

What is Value Investing?

Before pronouncing whether something is dead or alive, it is important to define what is it we are examining.  This is quite a bit harder than it seems.  Despite being a common description of an investment style, there is no universal, mutually agreed upon definition of value investing.  

As originally practiced by Benjamin Graham, value investing meant buying a company that was trading below the liquidation value of its current assets (cash, inventory, accounts receivable), after subtracting all liabilities.    Such opportunities were quite abundant in Graham’s day, the 1930’s, but are virtually non-existent today.

Graham’s definition expanded over time to include plant, property, and equipment.  This is a definition originally adopted by his greatest student, Warren Buffett, who then evolved further under the influence of his partner Charlie Munger.  There are some opportunities of this variety today, but they are very few in number and investors usually need to push for some kind of change at the companies for value to be realized.  This idea is the core of many activist investor campaigns today.    

Over time, value investing became to mean something more quantitative in nature.  This typically meant investing in companies that screen statistically cheap on some valuation metric: Price to Earnings, Price to Book Value, Price to Cash Flow, etc.  It had been, and for many still is, thought that buying the most statistically cheap companies in a systematic way led to excess returns.  

Eugene Fama won a Nobel prize, in part, for this insight.  Fama and French looked at all stocks, sorted them by valuation systematically, parsed them by decile, and concluded that buying the cheapest decile in a systematic way led to excess returns.  This approach worked beautifully in the sample 28-year period July 1963 to June 1991, the subsequent 28-year+ period has been another story. (The chart below illustrates the point.)

There are long stretches when statistically cheap does better and long stretches where it does not.  It leaves us wondering if academics have mistaken something that was episodic and cyclical in nature for something more permanent and structural.

Are Tales of Value Investing’s Death Greatly Exaggerated?

Yes and no.  Value investing is something that has evolved over time, as markets have, and continues to evolve.  We think buying statistically cheap will have stretches where it works and stretches where it does not, we believe it is something that is cyclical in nature.  There are many reasons why using statistical cheapness alone may not lead to structurally better results, as they have been thought to in previous generations.  Here are two possible rationales:  

Information today is more widely disseminated, and in a timelier manner than it had been in the past.   It used to be that investors had to wait to get quarterly and annual reports in the mail, and the process of printing and mailing them resulted in a substantial time lag.  Today, all of that information is available with the click of a button.  The whole market can see something looks cheap, while in the past, perhaps only a few participants could identify something as cheap in real time.  

Technology and disruption have led to a much shorter life expectancy for a variety of businesses, and they are changing everything.  At its core, the process of buying statistically cheap stocks systematically is a bet on mean reversion.  If things were bad and a stock was statistically cheap there would come a time when things were not so bad, and the stock could recover thus rewarding patient investors.  Today the pace and rate of change are increasing, and in many cases leave no mean to revert to and a lot of dead companies walking.  For some companies it may be darkest before the dawn, and for an increasing number of others the darkness will just fade to black.

What Does Accretive Think?

At Accretive, our definition of value investing is fairly simple but also flexible so it can evolve with markets.  We define value investing as trying to figure out what we think something is, or will be worth in the future, and paying less for it today.  While the practice of sorting and buying stocks on statistical cheapness alone may be much less effective today than it has been in the past, we think the concept of buying things for less than they are worth is timeless.

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