By, Robert J. Moss
Questions about the durability of value investing continue to be raised by the media as the decade-long bull market rages on. Sustained high valuations have limited investment opportunities for value investors, marking a structural change in the market and the death of value investing to some commentators.
Value investing was codified by former Columbia University professor, Benjamin Graham in his book, The Intelligent Investor. Over seventy years after it was initially published, The Intelligent Investor is still a staple of investing literature. In his book, Graham extolls the merit of investing in companies trading at share prices less than their intrinsic value. Intrinsic value is what the company should be worth. In the long run, a share price should correct itself to the intrinsic value, argues Graham.
Value investing is often contrasted to growth investing. Growth investors look for high growth potential companies, demonstrated through strong revenue expansion. Whereas value investors look for companies undervalued today, growth investors invest in companies they considered undervalued based on future expectations. Frequently, growth stocks trade at high valuations to compensate for that growth potential. Alphabet (Google) is a prime example of a traditional growth stock trading at a price/earnings ratio (P/E) of 30.84x.
Recently, news outlets have been quick to point out the lackluster performance of value investing as a whole. For example, in a CNBC article on the death of value investing, the writer points to the under performance of the iShares S&P 500 Value ETF compared to the iShares S&P 500 Growth ETF by 43.0% over the last five years.
Quantitative easing, the buying of government bonds by central banks to stimulate the economy, and the disruption of technology companies are commonly cited as explanations for value investing under performing. So, is value investing dead? Often the argument revolves around whether commentators believe the strategy’s under performances is structural or cyclical.
Structural proponents focus on the technological shift in the economy. Today, the top US companies are technological giants like Alphabet, Apple, Amazon, Facebook, and Microsoft. Commentators argue this has made valuing some of the best performing companies over the last decade more difficult for value investors.
Metrics associated with value investing like price/book value per share (P/BV), define a company’s book value based on their tangible assets. Practitioners use book value as an approximation of intrinsic value because the book value is, theoretically, the value of the company if it were liquidated today.
However, P/BV excludes intangible assets which have become more significant with technological advancements in modern companies. As Jonathan Haskel and Stian Westlake show in their book Capitalism without Capital, intangible investment has grown significantly in the US since the late 1940s to the point where it surpassed tangible investment in the mid-1950s.
The other side of the argument is value investing’s under performance is just a normal aspect of cyclicality in a particularly long bull market propped up by quantitative easing. Even BlackRock defends valuing investing in a blog post. In the post, they acknowledge the limitations of P/BV and explain that’s why they use multiple metrics to screen stocks for the their value ETF.
This highlights a framing issue around what constitutes value investing. Readers of the Intelligent Investor will know the Graham was not prescriptive about the means to assess whether a stock is undervalued. Instead, his book and subsequent finance books like Security Analysis, were more about strategy than a specific how-to.
Using P/BV is one alternative, but it’s not the only one. Pronouncing value investing dead, may be premature, especially when you consider how to define value investing. Ultimately, it will likely require the end of the current bull market to really test if value investing is dead.