Does Value Investing "still" work?

[Spekulatius]

The big question with Sears was, "who the hell wants these crap properties? And they were mostly crap. So who is going to pay 100% on the dollar for them? Are you??

 

In terms of value investing in general; of course it works - but you need to adjust to the world around you at some point, and stop waiting for the world to adjust to you (it's a balance). Low interest rates have made things difficult - we have boosted terminal values at the expense of near-term cash flows. Much harder to estimate at time zero.

 

If your definition of value investing is buying under 5x ebitda or 10x PE or 1x book, well unfortunately you are fishing in a cesspool of mediocrity.

 

So I definitely agree it is harder. Life is easy when you only need to estimate a few years of cash flows to earn your keep. 

 

With rates so low, now you have to estimate out 7, 10, or more years. This is a much more difficult task!

 

I think that’s one of the core things nowadays more so than before. Most of the money is made being correct about duration of the business, not the multiple now. You have to look further out. Being right about tanker spot rates in 3-6 month doesn’t provide much of an edge, but being right about a tech moat ten years out does.

[BPCAP]

https://www.institutionalinvestor.com/article/b1n5nhk92q3g62/I-Can-t-Believe-I-m-Saying-This-But-I-m-Passing-on-Seth-Klarman

 

 

If value investing is merely being poorly practiced by some poor practitioners someone better tell this guy called Seth Klarman that he is just a poor practitioner of the art

 

I admire Klarman a lot, but rarely do I think much of his equity holdings. But that doesn't matter. Stocks didn't make Seth Klarman; shrewdly finding distressed bonds and loans, workouts, and bespoke or one-off deals have been his thing.

 

He has been value investing--and successfully over time--but he hasn't done it in the securities most value investors operate in. 

[LC]

 

In terms of value investing in general; of course it works - but you need to adjust to the world around you at some point, and stop waiting for the world to adjust to you (it's a balance). Low interest rates have made things difficult - we have boosted terminal values at the expense of near-term cash flows. Much harder to estimate at time zero.

 

If your definition of value investing is buying under 5x ebitda or 10x PE or 1x book, well unfortunately you are fishing in a cesspool of mediocrity.

 

To double click on the idea of "adjust to the world around you" and metric of value, I've been thinking of this idea that in tech with proven earnings a P/E of 30 might be the equivalent of P/E of 10 in traditional industries. Reason: In proven tech companies with earnings, the total addressable market (TAM) is unknown because they open new markets. This does not happen with traditional commodities & industries - ie a pulp producer is unlike to evolve to clothing apparel retailer. With tech, a computer company (like Aapl) can become a music company and then a services company and then may become a health company. 

 

So if Aapl, Goog, FB are ever trading at a PE of <30, could be the equivalent of traditionally buying at PE of 10. Does that make some sense??

 

I think of it similarly, not in terms of TAM but longevity.

MSFT for example I think has good odds of being around for the next 10-20 years, with reinvestment opportunity.

 

Long time horizon plus reinvestment opportunity is a winning formula.

Unknown time horizon (short) plus lack of reinvestment opportunity is the opposite.

 

I’ll also play in the middle, the broadband providers I think have a long runway but not the best reinvestment opportunities. So here the initial investment price is a determining factor of final returns.

[mattee2264]

 

I think asset-based investments have always been quite suspect. Even for those with industry expertise it can be very difficult to estimate replacement cost or liquidation values. That is why Graham used to prefer buying liquid assets at a discount (i.e. net nets). But even liquid assets can disappear very quickly in a failing business eroding your margin of safety. So wide diversification is still required. And your upside is capped so your losers dominate your portfolio and becauase so many things can go wrong you really need a lot of diversification which makes it a lot of hard work and the scarcity of opportunities creates the temptation to dilute selection standards.

 

[Guest cherzeca]

 

In terms of value investing in general; of course it works - but you need to adjust to the world around you at some point, and stop waiting for the world to adjust to you (it's a balance). Low interest rates have made things difficult - we have boosted terminal values at the expense of near-term cash flows. Much harder to estimate at time zero.

 

If your definition of value investing is buying under 5x ebitda or 10x PE or 1x book, well unfortunately you are fishing in a cesspool of mediocrity.

 

To double click on the idea of "adjust to the world around you" and metric of value, I've been thinking of this idea that in tech with proven earnings a P/E of 30 might be the equivalent of P/E of 10 in traditional industries. Reason: In proven tech companies with earnings, the total addressable market (TAM) is unknown because they open new markets. This does not happen with traditional commodities & industries - ie a pulp producer is unlike to evolve to clothing apparel retailer. With tech, a computer company (like Aapl) can become a music company and then a services company and then may become a health company. 

 

So if Aapl, Goog, FB are ever trading at a PE of <30, could be the equivalent of traditionally buying at PE of 10. Does that make some sense??

 

I think of it similarly, not in terms of TAM but longevity.

MSFT for example I think has good odds of being around for the next 10-20 years, with reinvestment opportunity.

 

Long time horizon plus reinvestment opportunity is a winning formula.

Unknown time horizon (short) plus lack of reinvestment opportunity is the opposite.

 

I’ll also play in the middle, the broadband providers I think have a long runway but not the best reinvestment opportunities. So here the initial investment price is a determining factor of final returns.

 

it used to be that you created a moat (longevity) through brand development/equity.  now things are much more fluid and brands have less staying power.  platforms have replaced brands as moat creators.  msft has not been the most innovative company imo over last decade, but its platform is persistent.  of course, FB AMZN etc as well.  not value companies btw...

[LC]

msft has not been the most innovative company imo over last decade, but its platform is persistent.  of course, FB AMZN etc as well.  not value companies btw..

 

And why not?

 

Answering that question is a big part of this thread's topic.

MSFT, AMZN is not a "value" company? It's like the one true scotsman.

 

These two companies have created some of the most value, globally, in the last decade.

If anything, they are two of the most "valu"-able companies to ever exist!

 

 

[writser]

I think that's why this discussion always gets confusing. What is 'value investing'? I think that is up for discussion. My definition (I'm not saying it is the correct definition): buying a company for less than intrinsic value. That can be Facebook at 200x earnings, if you have done your homework and think it is worth more. It can also mean: buy some crap at a low multiple, if you have done your homework and think it is worth more. In both cases, the key is: doing your homework. Thinking about the business, stakeholders, incentives and valuation.. The rest is mostly a philosophical discussion as far as I am concerned.

 

If you buy stocks blindly because they trade at low multiples you have not done your homework. If you buy stocks blindly because of growth prospects you have not done your homework either. Maybe these strategies worked in the past, maybe they didn't. Maybe they work now, maybe they don't. Personally I don't care too much.

[Guest cherzeca]

"What is 'value investing'? I think that is up for discussion. My definition (I'm not saying it is the correct definition): buying a company for less than intrinsic value." 

 

well who wants to pay more than a company is worth? even growth bulls paying up for tsla think it is priced at less than "intrinsic value"...and so far they have been generally right...and I think we can all agree that tsla is not a value stock. 

 

for many investors who gravitate towards value, too much can go wrong with a growth story such as tsla.  I think some of what David Dreman said makes sense here...that value investing reduces risk of loss, and while at the risk also of giving up some upside, losses hurt more than gains feel good, and so weighting risk/reward to limit risk is an essential part of value investing...and it is fair to say that with the Fed so active (just read holds 14% of treasuries) and forecasting low rates as far as the eye can see, limiting downside is not as fashionable as it once was, generally speaking

 

 

[writser]

well who wants to pay more than a company is worth?

 

Well, that's a good question. Frankly I think a ton of people don't give a shit about valuation. They either don't do it at all and just try to sell to the next fool or they do it in such a preconceived way that they might as well not have done it. Tesla is probably a case in point. But if you study and model the company carefully and you get to a valuation of $10k / share, sure, I guess you can call that value investing (though I personally think you should work on your business valuation skills). But others would probably not consider this value investing because they define it as:

 

- taking care of the downside, like you suggested.

- buying a bunch of companies in the lowest percentile with regards to a certain multiple.

- buying stocks that everybody else hates.

- buying a stock that's cheap according to a spreadsheet.

- jerking off while spouting Benjamin Graham quotes.

 

So, does it still work? Depends on who you ask and what their definition is. The self-proclaimed Tesla value investor with a price target of $10k certainly thinks value investing is working this year .. That's why I think the question is kind of pointless and the key to investing is to get the modelling right in specific situations. If Chou is losing money the interesting question is not: "is value investing still working" but: "why did Chou buy X, Y and Z, what did he think at the time and why didn't these ideas work out?" Of course those are hard questions that require actual work to answer so we don't do that and dabble around a bit here about whether Tesla is a value stock or not.

 

As an aside, I think a lot of value investors are nerds and so they gravitate to the 'mathy' situations, i.e. low multiples, tangible book value. So do I. However, if you studied Amazon carefully in 2002 and came to the conclusion that it was a superb company with enormous growth prospects and that it was way too cheap, I'd consider that value investing too. I guess that requires more business acumen, risk tolerance and self-confidence and less math so it attracts a different crowd. I think there is not a lot of cross-over between these two groups. The business guys piss on the valuation spreadsheets, the math nerds piss on the 500x PE multiple. In both cases that's a weakness though, not a strength.

[Guest cherzeca]

@writser

 

well put, and your reference to AMZN leads me to another point.  Bezos is a genius. you may like him or not, but he is a genius. sometimes you have to invest in the jockey. but of course, contra, Neumann (WeWork) was and is not a genius.  great model, stupid execution...plus morality manque.  now where Musk fits into this spectrum is still up for grabs, but it seems he is trending to the Bezos pole (though still morality manque imo).  value investing does NOT like to invest in geniuses on the make.  but contrast Ms Barra and Mr Ford to Musk, and one has to wonder whether some exposure to the genius spectrum might do value investors some benefit...

[thepupil]

To help make some of these distinctions, I use the terms

 

“Value factor investing” (Low P/B, high earnings/divvy yield, cheapest quartile)

 

“Intrinsic value based investing” (underwriting an asset/company’s value and buying below that, it’s PE / boom multiple whatever may be low or high)

 

[investmd]

excellent points above by LC, Cherecza and Writser questioning why Amazon could not be a "value company". I like the comment also about value investing being "nerdy" and gravitating to "mathy" situations and missing out on the potential growth prospect.

 

Maybe what should be dead is the topic of "value" vs. "growth".  Maybe the markets have come to a new way of  "investing well" which blends assessing BOTH intrinsic valuation of assets and multiple of yesterday's earnings but also giving important consideration to earnings growth.

 

[writser]

To help make some of these distinctions, I use the terms

 

“Value factor investing” (Low P/B, high earnings/divvy yield, cheapest quartile)

 

“Intrinsic value based investing” (underwriting an asset/company’s value and buying below that, it’s PE / boom multiple whatever may be low or high)

 

Yeah, that’s a sensible distinction.

[Gregmal]

Posted in another thread...but figured this works here too. Seems to be a different year but the same story.

 

https://valuewalkposts.tumblr.com/post/138102275370/2015-letter-klarman-tell-investors-he-is

 

The “FANG” stocks (Facebook, Amazon, Netflix, and Google)

gained $415 billion of market cap through the end of the year, a 55% jump. Netflix stock surged 134% in 2015; Amazon 118%. Their average price-to-earnings ratio soared from 49 to 120 times, according to Bloomberg. As in the Nifty Fifty era, money managers seem to have decided they’d rather be seen failing conventionally than risk trying to succeed unconventionally. Last year, the 10 largest stocks by market cap in the S&P 500 gained nearly 23%, while the other 490 stocks were down about 3.5% on average.

 

“Value investors must be strong and resilient, as well as independent-minded and sometimes contrary. You don’t become a value investor for the group hugs. Indeed, one can go long stretches of time with no positive reinforcement whatsoever. Unlike some other fields of endeavor, in investing you can do the same thing as yesterday but achieve completely different reported results. In the long run, the research and analysis you perform should overcome market forces; the fundamentals ultimately matter. But in the short run, markets can trump effort and insight.”

[D33pV4lue]

I think that's why this discussion always gets confusing. What is 'value investing'? I think that is up for discussion. My definition (I'm not saying it is the correct definition): buying a company for less than intrinsic value. That can be Facebook at 200x earnings, if you have done your homework and think it is worth more. It can also mean: buy some crap at a low multiple, if you have done your homework and think it is worth more. In both cases, the key is: doing your homework. Thinking about the business, stakeholders, incentives and valuation.. The rest is mostly a philosophical discussion as far as I am concerned.

 

If you buy stocks blindly because they trade at low multiples you have not done your homework. If you buy stocks blindly because of growth prospects you have not done your homework either. Maybe these strategies worked in the past, maybe they didn't. Maybe they work now, maybe they don't. Personally I don't care too much.

 

Exactly how I would summarize it. Value investing is a philosophy centered around research and ultimately intrinsic value. It doesn't matter how you go from point A to point B (Low P/B, P/E, FCF). Whereas low P/B investing is a strategy the same way momentum is. I've commented this same theme before, traditional value investors haven't been able to adapt to more asset light business models. I am younger raised on traditional value investing but my personal philosphy skews more towards Joel Greenblatt value than Ben Graham. Markets change there are not many opportunities available to buy net cash companies. GAAP Accounting is a crappy indicator of "value" and hence P/B is rarely meaningful (exception insurance, etc.).  The only way to know what a company is worth is to do your homework.

 

cherzeca - I would argue that noone actually knows the intrinsic value of TSLA and it is pure speculation they may be right now but for the wrong reasons.

[SharperDingaan]

Trying to do 'value investing' purely by formula is pretty meaningless.

Assume 12 month forward earnings of $1/share, market P/E of 25x, current price is $40. To the value investor, the stock is overpriced to the $25 it is worth (25 x $1/share), and he/she should walk away. But if you expect 60% growth in 12 month earnings (ie: $1.60) ... the stock is fairly valued (1.60 x 25 = $40).

 

At any one time, consensus 12 month forward earnings are just a market guess. But compare any forecast strip price against the subsequent actual, and you quickly see how inaccurate these guesses are. All that we really know that is that if a company is in the early stages of a growth cycle, an earnings miss will typically bias upwards. The nearer to the maturity stage, the more random the bias.

 

So what? if this company was a Tesla, and in its early growth stage, you would think $40/share dirt cheap. Simply because a SINGLE 5% positive earnings miss is worth $2/share, and relatively easy to obtain as economies of scale kick in. Do it every quarter, and the P/E multiple will also expand.

 

Value investing still works, you just need to apply it differently. Change.

Something a great many value investors have real difficulty with.

 

SD

 

 

 

 

 

 

[John Hjorth]

Trying to do 'value investing' purely by formula is pretty meaningless. ...

 

... Value investing still works, you just need to apply it differently. Change.

Something a great many value investors have real difficulty with.

 

SD

 

I can't help quoting SharperDingaan here,

 

Screening the markets for cheap stocks can't hurt, until one engage. From a long perspective [, all kinds of financial instruments omitted here], losses are created by buying, gains are created by holding or selling.

 

It's not that hard to explain basically - a good deal harder to practice.

[Palantir]

You are laying out cash to buy a business to get more cash from business in future.

 

 

Not true. You are laying out cash to buy a business in the hopes that someone else will be willing to buy it from you at a much higher value. If the second part doesn’t happen then it didn’t work.

 

 

You do not actually get the cash a business produces...

[Guest cherzeca]

"cherzeca - I would argue that noone actually knows the intrinsic value of TSLA and it is pure speculation they may be right now but for the wrong reasons."

 

intrinsic value is a squishy concept to be sure...akin to a platonic form...you can't see it but it is there.  I have come to believe that if developed economies make a big push to lower emissions, the low hanging fruit is cars and trucks, and TSLA has a huge advantage right now, though I am not sure how durable it is.  if you are young and want to stow away assets in an IRA for a 20 year holding period, I could see TSLA.  now is TSLA a value stock? of course not, but it may have a not readily apparent but still huge intrinsic value, since you are discounting the future at a very low interest rate...and btw, 10 year treasuries have a 140 P/E given their current yield.

[coc]

Value investing hasn’t changed or been invalidated at all. The modern value investing deans have made a lot of mistakes. That’s it. Sears was a bad bet. GM spends almost all of it “earnings”, leaving no cash. Too many people are letting these guys fool them by arguing something “doesn’t work” just because they have made a lot of miscalculations.

 

Nothing has invalidated the idea of buying a business cheaply relative to its future distributable earning power. The whole net working capital stock thing worked because either:

(A) the company would liquidate (cash in your pocket)

(B) the company would develop real earning power (cash)

© the company would be acquired (presumably the new owner would liquidate or fix it like dempster mill )

 

There’s no difference between that and buying Apple at a $500B market cap which will produce $50-60B of free cash flow. Price, and cash flow. The opportunity can come in many forms. It’s strange that this is argued over so much.

 

Tesla is worth zero if it doesn’t develop distributable cash some day in excess of its losses. It’s called “speculative” because there hasn’t been any yet and the business they’re in is monstrously competitive.

[rranjan]

You are laying out cash to buy a business to get more cash from business in future.

 

 

Not true. You are laying out cash to buy a business in the hopes that someone else will be willing to buy it from you at a much higher value. If the second part doesn’t happen then it didn’t work.

 

 

You do not actually get the cash a business produces...

 

Some one else will eventually buy it higher from you 100% of times if value of owner's earnings are higher than price you paid.

 

 

 

[Ice77]

Traditional value investing usually focuses on businesses with hard assets and/or conventional distribution models. These businesses are being disrupted and losing market share with historic moats no longer easy to sustain. It is not so much that value investing is struggling but the geiger counter has not been adjusted properly to this changed landscape. Tech enabled or tech oriented businesses rely much more on deep qualitative insight than quantitative number crunching and that's less a domain of traditional value investing. To invest in an era dominated by a) near zero rates, b) low cost of acquiring/servicing marginal customers/deep network effects, c) asset light businesses, d) heavy index flows, one needs to make some adjustments to their geiger counters. Forget value investing, look at the amount of idea generation on this board now adays? It's miniscule. It used to be phenomenal. It's not like ideas are not being discussed anymore - just that the avenues have moved around (chat platforms/discord servers/dedicated fin social media/podcasts etc). The pace of change needs us to make adjustments to our geiger counters every now and then. 

 

 

 

[Palantir]

You are laying out cash to buy a business to get more cash from business in future.

 

 

Not true. You are laying out cash to buy a business in the hopes that someone else will be willing to buy it from you at a much higher value. If the second part doesn’t happen then it didn’t work.

 

 

You do not actually get the cash a business produces...

 

Some one else will eventually buy it higher from you 100% of times if value of owner's earnings are higher than price you paid.

 

Not necessarily, stocks can remain undervalued and under appreciated for a long time.

 

If your stock reprices to IV in 6 months or 6 years makes a big difference.

 

There are multiple variables at play

[thowed]

Trying to do 'value investing' purely by formula is pretty meaningless.

Assume 12 month forward earnings of $1/share, market P/E of 25x, current price is $40. To the value investor, the stock is overpriced to the $25 it is worth (25 x $1/share), and he/she should walk away. But if you expect 60% growth in 12 month earnings (ie: $1.60) ... the stock is fairly valued (1.60 x 25 = $40).

 

At any one time, consensus 12 month forward earnings are just a market guess. But compare any forecast strip price against the subsequent actual, and you quickly see how inaccurate these guesses are. All that we really know that is that if a company is in the early stages of a growth cycle, an earnings miss will typically bias upwards. The nearer to the maturity stage, the more random the bias.

 

So what? if this company was a Tesla, and in its early growth stage, you would think $40/share dirt cheap. Simply because a SINGLE 5% positive earnings miss is worth $2/share, and relatively easy to obtain as economies of scale kick in. Do it every quarter, and the P/E multiple will also expand.

 

Value investing still works, you just need to apply it differently. Change.

Something a great many value investors have real difficulty with.

 

SD

 

Great explanation.

 

This is effectively why I am more 'Fisher' than 'Graham'.  I go for 'Quality' because I like to be able to rely on a great Founder and Management Team to create the Growth that will make it good Value when I buy it.

 

 

[SharperDingaan]

Just to tie it into the behavioural thread on social norm bias ...

 

The 'formula' value investor looks to the price today, versus the price one-year ago - per mean reversion, if today's price is 70% less than it was last year, the shares are cheap! But the investor then measures performance, on a 1-yr TWR basis - 'cause that's the industry standard! Social norm.

 

Problem is that the 'formula' then fails miserably if mean reversion takes more than a year - O/G, airlines, Covid-19, etc.

Assume year-0 return was -70%, year-1 return is -20%, year-2 return is 3%, year-3 return is 250%.

• The 'formula' investor would buy at the beginning of year-1 - cheap at 70% off! End of year-1 ? the investor sells, takes the tax loss, and tells the world what a rancid POS this was! End of year-2 ? the investor looks back and congratulates him/herself on their great decision!, they made more than the 3%.
   
  The reality is that the investor is actually dumb as a brick. He/she never saw the year-3 return, and lost 20% of their dollar when they exited. Had he/she stayed they would have made 200% (1X30%x80%x250%=0.60/original investment=1x30%=.30). And more multiples still, had they simply stayed for year-4 - when mean reversion actually takes place (assumed timing).
  

 

It wasn't the approach that was wrong - it was the performance measure being used. Following the norm.

Severely cripples a value investor using OPM. But if you're private money, with a more relevant performance measure, it's help yourself time :D

 

SD