Aswath Damodaran: “If You Are A Believer In Value, As I Am, Good Value Investing Requires Creativity And Out-Of-The-Box Thinking”

Aswath Damodaran has just released his latest data update titled – Data Update 2 for 2020: Retrospective on a Disruptive Decade, in which he provides some extensive analysis on the last decade, and some advice for value investors saying:

I believe that good value investing requires creativity and out-of-the-box thinking, as well as a willingness to live with uncertainty, and even then, the payoff.

Here’s an excerpt from the article:

a. Value versus Growth

The basis for the belief that value beats growth is both intuitive and empirical. The intuitive argument is that value stocks are priced cheaper and hence need to do less to beat expectations and the empirical argument is that stocks that are classified as value stocks, defined as low price to book and low price to book stocks, have historically done better than growth stocks, defined as those trading at high price to book and high price earnings ratios. Looking at the annual returns on the lowest and highest PBV stocks in the United States, going back to 1927:

(Source: Raw Data from Ken French)

The lowest price to book stocks have historically earned 5.22% more than the highest price to book stocks, if you look at 1927-2019. Broken down by decades, though, you can see that the assumption that value beats growth is not as easily justified:

(Source: Raw Data from Ken French)

While there are some, especially in the old-time value crowd, that view the last decade as an aberration, the slide in the value premium has been occurring over a much longer period, suggesting that there are fundamental factors at play that are eating away at the premium.

If you are a believer in value, as I am, there is a consolation prize here. Assuming that low PE stocks and low PBV stocks are good value is the laziest form of value investing, and it is perhaps not surprising that in a world where ETFs and index funds can be created to take advantage of these screens, there is no payoff to lazy value investing. I believe that good value investing requires creativity and out-of-the-box thinking, as well as a willingness to live with uncertainty, and even then, the payoff.

The decade to come

It has been said that those who forget the past are destined to relive it, and that is one reason why we pore over historical track records, hoping to get insight for the future. But it has also been said that army generals who prepare too intensely to fight the last war will lose the next one, suggesting that reading too much into history can be dangerous. To me the biggest lesson of the last decade is to keep an open mind and to not take conventional wisdom as a given. I don’t know what the next decade will bring us, but I can guarantee you that it will not look like the last one or any of the prior ones, So, strap on your seat belts and get ready! It’s going to be a wild ride!

You can watch his entire presentation here: