Why value investing lost mojo and some say it sucks



Why value investing is performing poorly in the last decade? Why value investing lost mojo and some say it sucks.

Did something change structurally?

The short answer is yes.

Then what has changed the course of so-called value investing that used to be thought of as a golden rule of successful investing? First, generally-termed value investing is a strategy to invest in stocks with low price multiples such as PER and PBR. Low price multiple means the stock is priced relatively inexpensive, and selecting investment from this group means a portfolio of stocks is made of inexpensive stocks. It is called value investing. In the early 90s, academics of finance has proved value investing has an anomaly of positive relative return adjusted for risk, and Fama and French became known as the first to prove the existence of anomaly statistically.

When you look at the relative performance of this group in recent years and compare it against the entire stock market, you will immediately find that such an argument no longer holds.

In the last five years for US equities, Russell 3000 value index returned just over 30% while the Russell 3000 index’s total return was 66%. In the previous ten years, 158% and 250% respectively. For international stocks, MSCI All Country World ex-US value index returned 0.9%, and MSCI AC World ex-US index returned 19.7% in the last five years. In the previous ten years, 36.2% and 67.6%, respectively.

Some fund management companies claim generally-termed value stocks will revive, and some are claiming “value approach” & pursuing very concentrated strategies for low priced equities. However, I believe those low-price oriented strategies (I call it a low price multiple strategy to clarify my position on value, to be precise) would deliver intermittent positive relative return at best.

First, a low priced multiple strategy works only in a booming economy. It worked when economic cycles had a robust upward trend line. A group of low-priced stocks is primarily having some issues – either company-specific, industry-specific, or economy-related. The positive return occurs when things turn around, and the problems start to get moderate.

That recovery is more frequent and less complicated when the entire economy is expanding and absorbing difficulties. In a sense, an improvement from the low-priced condition gets harder when things are getting severe. In that case, only the strongest and fittest can survive. It would not be impossible for low-priced stocks to recover, but the efforts to make turnaround successful require substantially more careful management and robust execution. The window of opportunity got slim. That is why more and more private equities are trying to re-engineer those companies to generate a return. It is another side of the coin.

Secondly, the structural shift started in the mid-90s is continuing to shift the source of value-added from physical to intangible assets, implying the faster depreciation of tangible assets than accounting suggests.

Productivity is a primary source of intrinsic value growth driver, and if you think over the big picture since the 70s, although there has been a shift between a. volume-led productivity growth with leveraging the initial low cost and b. information technology-led productivity gain, it is information technology that worked consistently throughout the last 50 years.

But the initial study on low PBR effect by French Farma was done in the early 90s, and the dataset did not include the period where the industry shift has taken place. Cross-sectional analysis tells just that specific statistical attributes were confirmed from the past samples. Still, it does not provide a basis that guarantees that future samples are statistically indifferent from the prior samples used for research.

In association with it, there is an argument against using book value to classify companies into value and growth. The inherent flaw in book value comes from off-balance & intangible (such as a management team and employees) is not reflected in book value and is getting more critical. That leads to the assumption that companies with substantial intangible assets have a lower book value than they should. PBR should be lower for these companies.

It is an interesting discussion, but there will be no conclusion as ultimately, a company does not own and control all intangible assets, including human assets and various goodwill of the brand. Moreover, valuing such assets is too subjective to determine a fair depreciation method with a potentially large room of manipulative goodwill valuation.

Third and most importantly, there is a long-standing confusion of value investing (as well as growth investing) and its relation with value. Value investing, defined by French and Fama, was an investment in low PBR stocks. Value-oriented investing is a thoughtful act of the investment judgment that constitutes intrinsic value as a core & critical element. It has nothing to do with investment in a group of low-price multiple stocks. It is an equity selection strategy using a price multiple without analyzing intrinsic value. It is price-oriented rather than value-oriented.

That is why I use the name of a low price multiple strategy, not a fundamental value-oriented investing. It is a quantitative and price-oriented strategy, which is in essence an arbitrage trading strategy rather than a long-term investment. Just a name, but it carries different and confusing ideas. Mixing it with a genuine fundamental approach would make the implementation process inconsistent.

Fourth, value-oriented investing is evolving in response to the shifting whole economic picture. As the world population growth is getting slower under the post-financial crisis discipline of cash generation prioritized corporate finance environment, a window of opportunities to grow intrinsic value will continue to get smaller. As such, the relevance of a static arbitrage analysis of intrinsic value and market price at a point of time continues to recede. Instead, a dynamic analysis of the long term intrinsic value growth will become a significant and central axis of the next-gen value-oriented fundamental investing. 

Fifth, as even retail investors can quickly point out, the low-interest-rate environment does not help low-priced securities as much. Those low-priced equities are generally matured, so the intrinsic value is composed of the near-term cash flow more than future cash flow. In other words, they are short duration equity. The opposite applies to the companies with long-duration growth and in the early stage business cycle. However, as mentioned, the nominal interest rate has got affected by central banks’ actions, but its long term trend shows the structual lower growth of economies waiting for us ahead. So, just looking at an interest rate (either time-series-wise or cross-sectionally) independent from the assumed growth lacks the holistic perspectives.