Much ink has been spilt on the so-called demise of value investing. Despite overwhelming empirical evidence demonstrating otherwise, many minds are set on the misconception that stock markets are now being driven by the Federal Reserve.
Market consensus seems to be that fundamentals no longer matter; value investing is dead, and growth investing is the flavour of the month.
What do we think of value investing?
For many investors, value investing means investing in companies which are trading at low multiples. The infamous price to earnings ratio is one such example, others include the price to book ratio and the price to sales ratio.
By buying companies which are lowly rated by the market, many self-proclaimed value investors expect to outperform.
Yet, by its very nature, value investing is binary. A company might be trading below its intrinsic value either because the market is overly pessimistic about the fundamentals of the business or is correctly pricing in structural challenges or issues about the business (as is usually the case).
Value stocks or value traps?
Historically, many "value investors" have piled into banks, oil companies and automotive firms. By simply focusing on the price to earnings/book ratios, many value investors have simply bought a stack of value traps given that many businesses within these sectors are structurally challenged.
Trapped by their myopic views, many keep missing the wood for the trees and expect (by some divine right) value investing to finally regain its crown.
However, many factors conspire to render such a situation unlikely. Spiraling debt levels, aging populations and the technology boom all lead towards a deflationary environment.
ESG investing is gaining traction fast whilst the increasing importance of intangible assets is well documented.
Furthermore, rather than suffer from mean reversion due to the laws of diminishing returns, many highly profitable firms benefit from increasing returns which have led to an increasingly winner takes most environment.
Finally, we are on the cusp of major disruptive change which will lead to seismic shifts within the markets. Some companies will be major beneficiaries, yet again many of the so-called value stocks will be permanently disrupted.
All these factors led us to believe that many so-called value stocks are likely to be value traps.
At the same time many growth investors have been equally foolish. Certain businesses which have benefited from the pandemic have been bid up to stratospheric levels.
For example, we struggle to understand how Zoom could justify its $140bn market cap. Notwithstanding its stellar results, to us, we simply cannot predict with any degree of certainty that the firm will generate sufficient cashflow to justify its lofty valuation with limited barriers to entry.
As can be seen by Nikola Corporation, eager not to miss out, investors bid up shares up to shares up to nearly $94 dollars a share yet in less than two months, the shares drifted to below $40 dollars a share. Reality can, and will, hit hard.