How Value Investing Has Changed
Some growth stocks are now in the bargain category. Hare, welcome to tortoise-hood.
Art by Lars Leetaru
Like moviegoing and office occupancy, value investing is different these days. Exhibit A: Meta Platforms, the Big Tech company previously known as Facebook, is now classified as a value stock. A one-time stalwart of the super-momentum FAANG gang, Meta got plunked into the Russell 1000 Value Index in June, thanks to its reduced earnings growth and other factors.
Meta’s altered circumstances owe partly to its own internal problems and a strategy change. The stock’s reclassification illustrates the protean nature of public equities circa 2022. But it also shows that previous concepts of value have shifted.
Aside from welcoming faded stars to their ranks, amid a turbulent market, value faces more competition. Legacy value investors have new rivals in their quest for tarnished gems, including hedge funds, according to a study from investment manager CDAM. Long-term low interest rates, higher debt and slower economic growth also have played roles.
By traditional definition, a value stock’s worth is masked by a cheap price and investor misperceptions, while growth investing characteristically boasts rapidly expanding revenue and earnings, along with shareholder enthusiasm. Value is known for being boring, yet usually steady and unsurprising. “Value has been inherently more valuable because it is more stable,” explains John Mowery, CIO of NFJ Investment Group.
The standard definition of value stocks holds that they trade at a lower price than what they are worth, and bear characteristics like a low price/earnings ratio and often a dividend. This is the thesis forged by economist Benjamin Graham (1894-1976), the patron saint of value investing, who preached the wisdom of finding stocks’ actual worth, aka their intrinsic value, through rigorous analysis of financial fundamentals.
Value’s Twisty Trajectory
In a 1992 paper covering the previous three decades, two celebrated economists, Eugene Fama of the University of Chicago and Kenneth French of Dartmouth, demonstrated that value had handily returned more than growth.
Then the tides changed course, and along came a protracted stretch of growth dominance. This supremacy was only interrupted for a few years after the 2000 dot-com implosion and the 2008 financial crisis, when value temporarily leapt to the fore. “Usually, some event triggers value’s rise,” observes Cory Martin, CEO of Barrow Hanley Global Investors. Along the way, during those years upon years of tech’s dominance, value has seen its historical outperformance narrow.
Fama and French concur that growth has gotten a leg up since their 1992 paper appeared. They revisited their findings in 2020, and concluded that value’s performance edge over growth had shrunken in the interim, to 0.6% from 4.2% for large-cap stocks, and to 4% from 7% for smaller-cap shares.
Value has lagged behind growth over the past decade’s stock bull market. In 2021, the bounce-back year from the onset of COVID-19, growth was decidedly ahead, logging a 31.2% advance versus value’s 24.7%, per S&P Dow Jones Indices.
Growth’s advance was treacherously top-heavy, though, and slated to lose its balance. Witness Meta’s fate. In a research paper, Barrow Hanley showed that the biggest five stocks in the Russell 3000, which encompasses most of the U.S. equity market, were 14.3% of the index when the tech bubble burst. That ballooned to 23.3% at the recent peak, and has since deflated to 12.3%.
Growth Has Outpaced Value for Years—Until Now
As of August 18, 2022
40%
Growth Stocks
Value Stocks
30%
20%
10%
0%
-10%
-20%
5 Years
3 Years
2022
10 Years
2021
40%
Growth Stocks
Value Stocks
30%
20%
10%
0%
-10%
-20%
5 Years
3 Years
2022
10 Years
2021
40%
Growth Stocks
Value Stocks
30%
20%
10%
0%
-10%
-20%
5 Years
3 Years
2022
10 Years
2021
40%
20%
0%
-20%
10 Years
5 Years
2021
3 Years
2022
Growth Stocks
Value Stocks
Source: S&P Dow Jones Indices
Amid all this, value has staged another comeback. Credit geopolitical and macroeconomic upheaval, as Barrow Hanley’s Martin puts it. Thus for the moment, we’re living in another time of value primacy—as of January, anyway.
Classically, value does best during bear markets and recessions, and also when strong inflation surges. Thanks to 2022’s inflation- and war-spooked market, value and growth traded places with a vengeance. As of last week, growth had tumbled by 15% this year, while value lost only 3.4%.
What Has Changed With Value?
Time was that value afficionados had the bargain-finding field to themselves. Look at the story of Apple, the hot stock of the 1980s. The company lost its way in the 1990s and was on the verge of bankruptcy when Steve Jobs returned to right the ship. In the bad years, it took a real value genius to see that Apple could be resurrected, let alone ascend to its present glory as the nation’s most valuable corporation. Some shrewd value investors profited nicely.
But in recent years, as the CDAM study indicates, hedge funds have expanded mightily, doubling assets between 2008 and 2015. Many of the hedge operators, the paper relates, are “employing a value/special situations approach, thus increasing the competition for bargains.” Add in a large dollop of new quant funds in search of unsung quality value stocks. Another trend, the proliferation of index funds, has led to the gobbling up of still more undervalued stocks to fill out the funds’ inventories.
Other influences include many years of low rates, which has encouraged bigger debt loads—giving investment pros more financial wherewithal to ferret out good buys. Years of slow U.S economic growth and business formation constitutes another influence; fewer public companies mean more compact hunting grounds.
Value devotees, of course, are thrilled at the investing style’s return to the lead. To Robert Arnott, founder and chairman of the board at Research Affiliates, the current high inflation is a big buy sign for value stocks. “If inflation is running hot, what do you do with your investments?” he said to ETF.com. “Firstly, value beats growth when inflation is rising.” Hence, he advised, load up on value.
How long will value’s reign be this time? Absent a sudden economic rebound and the vanquishing of rabid inflation, it may have some considerable room to run, strategists say. Brian Frank, CIO of Frank Capital Partners, thinks that “this could be the big golden age of value.”
Value investing is not easy to do. Bob Jacksha, CIO of the New Mexico Educational Retirement Board, notes that the difficulty is that value involves deep-dive stock-picking, and a lot of people are in that game now.
“At the end of the day, everybody wants to buy something at a discount, whether it is an investment asset or a pair of socks,” he says. “That is why it is difficult to make superior returns as a value investor. Your perception of the discount probably has to differ from the consensus.”
To many asset allocators, value and growth are part of their wide-ranging strategies, and tilting toward one or the other is often not done. Jacksha says he has no opinion on whether now is the time to buy value, because most of his fund’s public equities are in index vehicles.
Today, even the most devout value investors have loosened their rules. Warren Buffett, value player extraordinaire and a student of Graham at Columbia, has moved his holding company/investment pool, Berkshire Hathaway, into tech stocks, which typically are in the growth category. Says NFJ’s Mowery, “Buffett doesn’t look at value in the traditional sense.”
Berkshire’s top holding is Apple, which constitutes 40% of the portfolio, and carries a 28 P/E—lofty, by value standards. Buffett has explained his preference for Apple as respect for the strength of its brand and the indispensability of its products, particularly the iPhone.
Value Traps
Trouble is, absent any deep examination of fundamentals, an unwitting investor could end up with “some pretty crappy companies,” says Scott Davies, co-founder and CIO of CDAM. The consequence, he warns, are “value traps,” where cheap share prices and a smattering of encouraging metrics beguile investors into buying what they should avoid.
True, there have always been value traps. It’s hard to say if today has more of them. But a volatile market under the threat of a pending recession, a persistent pandemic and high inflation have generated a fair amount of traps.
A prime example of a value trap, to many analysts, is Gap, a retailer that appeared to be coming back after losing out to nimbler clothing merchants. In 2019, Gap sported a thrifty P/E of 8, as earnings per share rose. The stock got a brief reprieve during the post-lockdown consumer buying binge. But now, it is unprofitable and the stock has tanked.
What value traps are lurking out there today? CDAM’s Davies points to Meta as one possibility. Indeed, it changes hands at a bargain 14 multiple. “Its legacy business is down, so it is spending $10 billion” to expand into the metaverse, whose promise is far from assured, he comments.
Still, wise value investors such as CDAM know that good buys can be found. Ask Graham, Fama, French and Buffett.
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