Is value investing dead? It would surely seem so. In 2023, the widely quoted Russell 1000 Value Index, which measures the performance of large-cap value stocks, lagged the Russell 1000 Growth Index by a stunning 31.2 percentage points. Growth investors scored a gain of 42.7%, while value investors received a relatively paltry 11.5% return.
For longer time periods, as well, growth has trounced value. Over the past five years, for example, growth stocks generated a 19.5% annualized return, while value stocks produced a 10.9% annualized return. While the 8.6 percentage point spread seems less daunting than last year’s gap, the cumulative effects over the five years are debilitating: growth investors ended up with $2.44 for every dollar invested, while value investors ended up with only $1.68.
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The 10-year picture is little different. Growth stocks appreciated at an annualized 14.9% pace, compared to 8.4% for value stocks.
With the apparent consistency and vast scale of its outsized performance, growth investing appears to be the clear choice for long-term superior returns.
However, investors riding this wave today are explicitly assuming that the future will be a continuation of the past. Some facts that may temper this certainty:
· Over the past three years, which includes a highly volatile yet growth-inspired stock market, value and growth have exactly the same rate of return: 8.9%.
· Small-cap stocks, which exclude the effect of the mega-cap Magnificent Seven tech stocks, show almost no edge of growth over value. The 10-year pace for growth stocks (+7.2%) narrowly exceeds that of value stocks (+6.8%), while the 5-year horizon puts value stocks’ 10.0% rate of return ahead of growth stocks at 9.2%.
· The past 10 years have featured near-zero interest rates and a gusher of readily available funding for almost any venture, regardless of viability or profitability. These have provided an exceptionally strong tailwind for growth stocks – but this weather pattern is now gone and not likely to return for the foreseeable future.
· In other developed countries, there are no Magnificent Seven stocks or anything like them. The runaway recent success of growth investing in the United States seems to have been heavily dependent upon continued success of a narrow handful of expensive stocks.
· More subtle but just as critical, value investing is much more complex than merely buying a broad index of statistically undervalued stocks. The Russell Value Index, created by FTSE Russell, defines value investing as “those Russell 1000 companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium term (2 year) growth and lower sales per share historical growth (5 years).” Included are a heavy weighting of energy, financial and industrial stocks along with a broad swath of healthcare, consumer, utility, technology and others.
But, value investors don’t buy entire indices. Buying an index of 847 stocks (the current number in the Russell 1000 Value Index), weighted by market cap, makes no sense. Rather, value investors search for only a few stocks, perhaps 20-30, that are significantly undervalued. This small selection could come from any industry or sector – it depends on where the best single-name opportunities are. This is a very different game and one that no broad-brush index can even remotely hope to capture.
· In his third quarter 2023 letter, Bill Nygren, portfolio manager for noted value investor Oakmark Funds, quotes Benjamin Graham: “The intelligent investor is a realist who sells to optimists and buys from pessimists,” and goes on to write, “The optimists who buy exciting businesses regardless of price have been on quite a run, resulting in today’s unusually wide spread of P/E ratios.” Value stocks as measured by the Russell 1000 Value Index trade at a 15.5x price/earnings multiple, less than half the 32.8x multiple for growth stocks. And, these multiples exclude unprofitable companies which primarily haunt the growth indices. Growth investors need to be certain that this valuation spread will continue to widen indefinitely.
So, before writing off value investing as dead, look deeper than the widely used narrative. As Mark Twain is quoted to have said, “It ain’t what you don’t know that gets you in trouble… it’s what you know for sure that just ain’t so.”
As specialists in value investing, we focus on companies that trade at sizeable discounts to their underlying value. We do all the extensive analysis and valuation work to help you benefit from truly undervalued stocks. Our capabilities save you time while boosting your chances of profitable investing.
Best regards,
Bruce Kaser
Chief Analyst
Cabot Turnaround Letter and Cabot Value Investor
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