By Peter Mastrantuono
Value stocks have substantially trailed growth stocks during this 10-year bull market run, leading many investors to wonder if value investing, an investment discipline pioneered in the 1920s, remains relevant in today’s market.
Value investing is broadly defined as buying companies that trade at low prices relative to their earnings, sales or book value. Said differently, value investing focuses on owning companies whose current valuations are well below their true value.
Experienced investors know that market leadership among the different asset classes varies over time. The cyclicality of relative performance also exists with investment disciplines, i.e., value vs. growth investing. For instance, growth stocks outperformed value stocks in the late 1990s and, of course, in the years following the Credit Crisis, while value stocks enjoyed superior performance in the period between the bursting of the tech bubble and the financial crisis.
The question investors are increasingly asking is whether this recent period of value underperformance is simply a case of a normal, albeit extended, phase in market leadership rotation, or if it is more structural in nature.
Many believers in the “death of value” point to a number of factors that may be behind value’s persistent lagging performance. Chief among them are low interest rates, the democratization of data, which makes finding underpriced investments easier and therefore reflects in higher multiples, passive investing and higher regulatory costs that have squeezed margins.
Perhaps the most dominant reason for underperformance may be because accounting and value investment principles have not kept pace with the 21st century economy.
For instance, the price-to-book ratio (i.e., what a company trades at versus the value of company assets) is a useful gauge for assessing the value of businesses that are predominantly comprised of physical assets (plant, equipment, etc.). When a company is valued below its book value, it is considered an attractive value investment.
For many of today’s leading businesses, however, physical assets are less important than their intangible assets (patents, intellectual property, etc.). Indeed, companies in the S&P 500 have intangible assets that are five times the value of tangible assets, unlike in 1975 when intangible assets represented only 17% of the S&P 500 index companies, according to Aon, a leading global risk, retirement and health solutions provider. Moreover, from an accounting point of view, intangible assets are expensed rather than capitalized, reducing company earnings.
While the headwinds for value investing may argue for indefinite (even permanent) underperformance, one rule of investing should never be overlooked, to wit, “Trees do not grow to the sky.”
Many of the reasons for growth stocks’ outperformance in the last decade are not necessarily permanent fixtures. For example, some growth stocks may be priced for growth that they are unable to sustain. Their superior earnings growth has come in a benign regulatory environment and monopoly-like positions in their space. With increasing attention paid to privacy and corporate responsibility by Washington D.C., some large tech firms may find it more difficult to keep up the torrid growth pace.
The uncertainty around the continued relevance of value investing has significant implications for long-term oriented portfolios. Accordingly, investors should seek the counsel of an experienced financial advisor for added perspective.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.
