In conversations on Value Investing, references to the 1962 New York Mets have been coming up more often, and that’s not a good thing. The 1962 Mets are beloved for losing a staggering 120 games -- a record for the history books that spurred then-manager Casey Stengel to despair, “Can’t anybody here play this game?”
Value Investing too is on a losing streak. The common wisdom has been that Value Investing outperforms its rival Growth Investing over the long run, but over shorter periods, Growth and Value take turns doing better than the other. The problem for Value today is that it has been waiting an awfully long time for its turn, while Growth’s dominance has been impossible to ignore.
So full disclosure: We are Value Investors. We’ve always believed in buying the stocks of unpopular companies that look cheap and then staying patient until prices revert to fair value. Likewise, we have shunned the excitement of fast-moving companies and the high prices Growth Investors are willing to pay for them.
Put another way, we believe in reversion to the mean: The popular eventually become less popular and vice versa. But today we find ourselves in a world where go-go growth stocks like Amazon and Alphabet just keep going, and the downtrodden can’t seem to get a leg up in the world.
The thing about a losing streak is that you never know when it will end – or if it will -- and the longer it goes on, the more you wonder. But as Value Investors, we can’t shrink away from this. We have to look at this squarely in the eye. So what are we thinking?
First, we still firmly believe in the core principle of Value Investing, which is simply buying things when they are cheap or priced below fair value. That’s intuitive. Have you ever heard Warren Buffett’s partner Charlie Munger say, “All good investing is Value Investing, by definition”? There you have it. Investing is about what you pay for what you get, and that’s straightforward.
The struggle today is in looking at fair value the right way. We know we’re not living in the world of Benjamin Graham, the father of Value Investing who noticed that stock prices fluctuated a lot more than the value of a company’s underlying assets. Graham focused a lot on the value of a company’s assets, especially its tangible assets like factories, machinery, trucks and railcars. And while we have long done the same, we also recognize that today we’re in a world where intangibles like technology and intellectual property matter a lot.
The biggest companies today are not GM or GE. They are Microsoft, Apple, Amazon, and Facebook. Airlines and steel companies are one thing. Software or entertainment companies are another, and it’s a different game to think about what intangible assets are worth and how they turn into future cash flows. That doesn’t mean that valuation principles go out the window, but it does make the work harder. We’ve never been a fan of looking at ratios or multiples alone because investing has never been as easy as simple metrics. But today more than ever, we spend more time thinking about earnings quality and competitive position and where a company sits if its industry is being disrupted.
We also have to acknowledge that mean reversion may be a long time coming for some companies that enjoy powerful network effects. Network effects are where businesses become more valuable and powerful as more people join their ecosystems. For example, the more people that join Facebook, the more that others want to join, and the more market share Facebook can take. Or the more people that join Amazon Prime, the easier it is to spread the costs and invest in even more member benefits, which attracts more people. These situations give rise to a “winner take all” environment where winners keep winning and recovery gets harder for those who fall behind.
Nothing lasts forever and things can’t keep growing to the sky. Gravity still exists. But we also recognize there can be long-lasting value in a company’s network effects even if its price-to-earnings multiple looks high.
In sum, we think Value Investing has legs because Value Investors have been adapting to a changing world since Ben Graham first wrote Security Analysis in 1934, and they will continue to do so. Warren Buffett can buy Amazon stock, and the principle of separating price from value endures.