Lemon_tm
As widely reported, many in the financial services industry and media consider value investing dead in the water. I believe value investing is alive and well and forever, but what do I know?
Well, I know that many of the premier investors in modern history are value-oriented. William Browne, Warren Buffett, Mario Gabelli, Benjamin Graham, Joel Greenblatt, Seth Klarman, Peter Lynch, Howard Marks, Bill Miller, Charlie Munger, Michael Price, John W. Rogers Jr., Charles Royce, Walter Schloss, Sir John Templeton, Geraldine Weiss, and Martin Whitman are legends.
These value investor household names remind us that the practice of owning the common shares of quality companies with wide margins of safety at the time of purchase is as enduring as rock and roll and electricity and that the Earth is indeed round.
Anything with promise, value investing included – and despite ever evolving and persevering – has its lapses in popularity or delivery methods. Nevertheless, there is no equal to value investing for individuals striving to build and maintain an enduring portfolio that finances the indispensable milestones in the lives of loved ones.
On the Death of Value Investing
Value investing is never dead; it’s less popular than short-term growth stories. And value prevails as long as there are financial markets or farmers’ markets.
Although it is essential to underscore that I remain a die-hard value investor, the investment paradigm was out of favor on Wall Street during the momentum growth post-Great Recession bull market, making it more challenging to attract readers if the word value appeared in the title. In hindsight, I could, would, and should have bought Amazon (AMZN) shares at about $600 when its paid subscription service, Prime, began to take off in 2016. Or Netflix (NFLX) in 2013 for $50 when the company started streaming original content. And Alphabet (GOOG) (GOOGL) in 2004, when its IPO was available to retail investors for a split-adjusted $2.70 a share.
Toward the end of the epic bull, it became vogue for long-time celebrity-named value investors to bite the bullet and buy the more speculative, non-dividend-paying growth stocks. In other words, this time was different until it wasn’t.
For better or worse, at the time, I passed on each of those trends and other momentum growers as speculation. Instead, I focused on researching and purchasing stocks of boring, out-of-favor, albeit excellent companies outperforming the S&P 500 as a group since the dates I added the representative shares to the portfolio. Wall Street seems to struggle in generating Hamptons beach house-size bonuses on buy-and-hold value investing; instead, it promotes speculative investment trading paradigms, producing fees that build those summer cottages.
Whose beach or lake house are we building – ours or our financial advisor’s?
Perhaps there are diverging interpretations of traditional value investing or quality compounders purchased at attractive prices. Trading value stocks is the equivalent of buying cigar butts or shares of lower-quality companies on speculation and then selling based on an expected or hoped-for corporate, industry, or macro-driven event. In contrast, value investors continue to add fresh ideas to their portfolios that offer compelling prospects for compounding capital gains and dividends, protected by adequate safety margins to preserve principal during the inevitable market declines.
Remember, future returns are uncorrelated with past performance. Nonetheless, the objective of quality-driven value investing is to outperform the benchmark over extended periods – seven to ten years or more – knowing monthly, quarterly, and annual performances are at the whim of the market’s voting machine cast from irrational investor behavior or the occasional surprise event. It is better to seek the benefits of Graham’s longer-tail weighing machine of compounding returns and margins of safety.
Before the COVID-19 pandemic, the epic bull market – propelled by non-dividend-paying growth, forward high yields, cryptocurrency, and other speculative investment strategies – seemed unstoppable. Some market luminaries questioned the enduring legacy of value investing or declared its imminent death. A bull market for the ages precipitated the argument as growth stocks, momentum trading, trend following, and high-yield dividend equities, among other speculative portfolio strategies, outperformed the more risk-averse value approach.
Perhaps value investing is too long-term and too low-cost for a nearsighted, over-sophisticated financial services industry bent on collecting exorbitant fees and bonuses from its legion of followers. Nevertheless, trying to predict trends, catalysts, and macro events that produce profitable trades with consistency befits a game of chance more than a legitimate professional practice. Despite the noise, value investing triumphs because value does matter in everything we buy, hold, or sell.
Investments in quality, predominantly dividend-paying companies at value prices endure well beyond the scrap heap, where perennial bull markets for the ages dump the portfolios of investors chasing fast money in the euphoria of “This time is different.” History argues otherwise.
Value investing is neither dead nor dying and survives as a superior strategy. The post-Great Recession secular bull market was camouflaged, with the die-hard practitioners waiting in the bushes, ready to pounce on the falling stock prices of enduring enterprises.
We are comfortable in acknowledging that value prevails in every market cycle.
The Downside to Value in Extended Bull Markets
The inherent risk to the value investing model is the non-value investors that permeate market cycles.
Chasing the dragon named market bubbles has been a cornerstone of investing for Wall Street professionals and Main Street do-it-yourselfers since stock trading began. Human behavior dictates that it’s off to the races once we outsmart the market and predict this swing or that trend or go long or short just right on a company or sector. Convinced of figuring this thing out, we begin the hamster roll of predicting and trading unrestrained.
As validation, there are always reputable assists from outside market influences to our preoccupation with market trends. Of late, there was an assist from the Federal Reserve in keeping interest rates low until they didn’t. Before that, the hand-off came from government deregulation of the housing market, allowing widespread homeownership, fueling opportunistic investment banks to package the mortgages into marketable securities, and creating more risky mortgage dollars to lend to marginal home buyers.
Before the high-rated – despite no documentation and no income – mortgages, there was an assist from the capital markets of free-flowing investment into dot-com ideas that were just that, ideas. And before that, junk bonds made financing impossible mergers and acquisitions possible. Yes, the greatest threat to an investor is the market itself; however, the market is also a friend to count on for delivering individual company or market-wide value opportunities. Dedicated value investors stay patient and self-disciplined without knowing when or how those opportunities will emerge.
Prepare for the imminent next downturn with dry powder in the form of FDIC-insured cash to ride the ensuing upside in the stocks of quality companies becoming value-priced by the sudden extreme preference for discomfort among the herd of market-timing investors. Rest assured, when market crashes occur, the speculators with blind faith in trend following, momentum trading, forward high-yield dividend investing, and the next trading fad yet to be determined will be running for the hills.
As value investors, downturns in the market and targeted quality enterprises are our workdays. The ensuing upturns are our paydays.
Financial Markets and Farmers’ Markets
The proverbial day of reckoning is inevitable, although unpredictable. Thoughtful value investors never stress over failed short positions, diminishing fund assets under management from departing performance chasers, or useless self-doubt fueled by the 20/20 hindsight of missing out on the fast growers, high yielders, and Bitcoins when trending skyward. Several Enrons, Blockbusters, WorldComs, and Lehman Brothers exist for every speculative winner, such as Amazon.
Take extreme comfort in knowing that value prevails as long as there are financial markets or farmers’ markets.
Why the Trend is Rarely Our Friend
By definition, trend followers pass on the underfollowed player in an underappreciated industry. Nonetheless, following the trend or practicing momentum investing is fleeting, favoring nearsighted, speculative trades that come and go with market cycles and fads.
Common sense suggests that a slew of short-term momentum trades is required to make the same potential profits from just a few long-term investments in the publicly traded shares of quality companies purchased at reasonable prices. The winning long-term holdings were bought at value prices because the traders sold them off during a negative trend.
Buy slices of businesses because each appears in demand by the customer yet trades at value prices because of temporary mispricing by the market. Well-managed, concentrated stock portfolios have an adequate allocation of defensive, noncyclical holdings for the eleventh hour of any bull market.
Skeptical, nearsighted investors cite political grandstanding, trade wars, commodity pricing dilemmas, livestock supply issues, occasional product recalls, and other inconsequential grievances as justification for short-sighted momentum trades and trend following. And worse, offer death knell sentiments for companies domiciled outside the US. Being receptive to the compelling counters to an investment thesis, when the value investor hears, “Stay away from car companies,” the auto industry becomes a sudden and curious interest.
It is incredible how the investment world, on the whole, believes the present market, whether bull, bear, or range-bound, is somehow different, ignoring that business and market cycles come and go at random. Having the newest and latest investment fad to rally around is the differentiator in each market cycle. It reminds us of being in high school all over again.
Take preference for the perception of intrinsic value instead of estimations or calculations. Be skeptical of specific price targets, earnings projections, and other attempts at precision from the sophisticated financial models of sell- and buy-side analysts when attempting to determine the difference between the market price and the underlying value.
When you read, “XYZ is trading at a 40 percent discount to intrinsic value,” remember how Wall Street justifies enormous fees and bonuses with predictions unnecessary in the scheme of things. If these market pundits were often right rather than wrong, we’d become wealthy by following them. Before taking the prediction at face value, conduct independent due diligence.
For example, in mid-2011, the common shares of Microsoft (MSFT) were trading in the low- to mid-twenties. Did I calculate through discounted free cash flow analysis and other complex formulas that Microsoft compounds as a sixteen-bagger twelve years later?
No, although my perception was that the market undervalued the stock despite its Windows software legacy, strong fundamentals, hoards of cash, and other positive areas of the operation. At the time, the activist investment community was taking issue with the chief executive officer (CEO), and I figured at some point, he would resign, retire, or get replaced. Thus, I invested a dividend-adjusted $20.35 a share, thinking it would go up more than down over the long term. My perception was driven by a real-time cognitive analysis more than an assumption-driven specific future price target. As of July 21, 2023, market close, MSFT was trading near $350 a share, about sixteen times the cost basis, adjusted for splits and dividends. The holding gained nearly 134,000 basis points more than the S&P 500 during the same period.
Over-analysis or setting price targets often gets individual investors – and perhaps professionals – in trouble from timing trades. The analysis paralysis of publicly traded companies and the underlying stocks leads to extreme shorting or put options trades, as there is bad news in every security.
I am a reformed investor from lessons learned. The slow and steady investor knows that stable companies appreciate in the long run, as active traders moving in and out of positions in reaction to good and bad news get punished in the short run. Follow populist stock trends to our potential peril, or we can invest in great companies over a long-term horizon and benefit from compounding with a margin of safety.
Thoughtful, disciplined, and patient investors chase quality and value.
Copyright 2023 by David J. Waldron. All rights reserved.
