The Difference Between Growth And Value

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During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed The Difference Between Growth And Value. Here’s an excerpt from the episode:

Tobias Carlisle:
In the course of doing that last little bit of research that I did, my state of value address, part of that is looking at alternatives that you have. So value defined in that paper as the value decile. That’s the 10% that is cheapest on any given simple price ratio. And then I looked at a combination of those price ratios and to find what does the… if you don’t believe in price to earnings or price to cash flow, enterprise value to EBITDA, whatever, what do they all say together to give you a rough idea. And then just I also acknowledged in that paper and I liked the way Cliff did it actually, Cliff gave me the idea for it. I didn’t put my own model in, but Cliff did and his paper and the idea is basically that when you apply, so I don’t just use price ratios just so everybody’s clear on that.

Tobias Carlisle:
I also look at balance sheet, health, risk of financial distress, fraud, earnings manipulation and a variety of other things that I don’t always talk about but including in there is share buybacks on the long side, on the short side, basically it’s an inversion of that process, negative free cashflow, and so on. When you add all of those things in, the spread looks a lot wider than it normally does. And the spread that I’m talking about is between the most overvalued and the most undervalued. But included in the most overvalued stuff I don’t want to own because it’s a junky balance sheet. It’s negative free cash flow on the long side. It’s a good balance sheets, it’s positive free cash flow. It’s buying back stock, issuing stock for the most part. Any of those things by themselves is a pretty good distinguisher between the cheap and the expensive.

Tobias Carlisle:
Having said that, you still go through these periods of time where the expensive leg, the growth, the glamour, however you want to describe it, we might have to come up with another name for it. But I think glamour is a pretty good description of what it is because it’s basically the narrative has wildly diverged from what the financial statements are telling you. The financial statements are, if you looked at them, they’re almost uninvestible while they’re uninvestible their stocks, their shorts but they still go up a lot year after year, after year often because the top line is so good. But the top line growing and none of that falling to the bottom line or the company having to keep on financing. Sometimes those things do tend to integrate businesses, but it’s much, much rare than everybody thinks. So I just make a distinction and I know in the literature the distinction is between growth and value and the distinction is the price that you pay for the assets.

Tobias Carlisle:
So value tends to pay lower, I mean much, much lower multiples. In fact, they tend to often that value basket is the price is less than the flow. So you’re paying less than one times earnings, so less than one times book or much less than one times book. And on the long side you’re paying multiples of those things. So there are markets where that long side works. We’ve been through one recently for the last five years, particularly where the long side has worked really well. But you have to realize that that is an unusual thing. Now, Buffett says value, growth is a component of value, which is absolutely true if you’re doing a discounted cashflow analysis. But when you’re thinking about these things, you should think about the amount of weight that is in the terminal value versus the amount of weight that’s in the foreseeable years that you’re discounting back.

Tobias Carlisle:
If you find that you’ve got an enormous amount of weight in your terminal value, you’ve got a lot of work to do to prove that up. I’m not saying don’t do it. I’m just saying recognize the bit that you’re making. So when I do these things, I don’t like to have a lot of weight in the terminal value. I like really near-term cash flows because I think that they’re much, much more achievable. When I test it over the full data set, you get good returns. Now, the argument is that something has changed over the last five or 10 years. We’ve got so good at screening. Everybody knows what these companies are. Everybody’s hunting for these undervalued companies. You’re better off paradoxically hunting for them in the most overvalue because nobody’s looking there for longs.

Tobias Carlisle:
And so that seems to have been a better bit, but I make a distinction between the two, just so everybody knows what style of value investor I am and what I am doing when I’m discussing these things. It’s not confusing at all. You don’t have to be confused about this stuff and you don’t have to remind me about Buffett’s quote. I’ve read Buffett’s letters a few times. I’ve written about them a few times too, so I don’t need to, I’ll listen every time.

Bill Brewster:
Wait, do you understand that growth and value are joined at the hip?

Tobias Carlisle:
I’ve never heard that expression. What does that mean?

Bill Brewster:
Well, I just I wanted to maybe say it a different way. They’re a component of each other. Yeah. No, I think what you’re saying makes… I mean, it’s a ton of sense. It’s a shame to put it in longer terms, the two terms, cabbage people’s minds, right? And then they just, people start shouting past each other. I think that with what we’ve just been through, it has illuminated some of the risks to the near-term cash flow. But I also think you have to understand that this is a greater than three standard deviation event at a minimum. I don’t know how many standard deviations it is, but we’re definitely not living in the normal, so I don’t know that you can go underwrite what would this business look like at zero revenues for however long to stress the near-term cash flow?

Bill Brewster:
But yeah, I mean the terminal value, you introduce a ton of interest rate risk into your bet too. As you said, know your bet. I don’t know which one is right or wrong. I just think people that can articulate what the bet is are the ones that are going to ultimately hold the bag.

Sayre’s Law

Jake Taylor:
So what are some good names than what we could use to end this argument that it’s academic versus practitioner in a way of value growth?

Tobias Carlisle:
I always say it’s a good example of Sayre’s law.

Jake Taylor:
I love glamour. Glamour’s a winner there, right? We have that one [crosstalk 00:23:26].

Tobias Carlisle:
And I use glamour. I don’t use growth. I think for the most part I try and use glamour because I’m not trying to describe high growth companies. There’s nothing wrong with owning high growth companies. Just as long as you recognize the risks to owning high growth companies, you got to look at the statistical tables, you got to look how likely it is that they can sustain that growth rate. Some of them do.

Jake Taylor:
What’s that law? It’s pretty funny.

Tobias Carlisle:
Sayre’s law, that one, the intensity of the argument is inversely proportionate to the size of the stakes. The lower the stakes, the more intense the argument. It’s an academic kind of thing. I don’t care. I know what I’m doing and I’m describing mine as value. So if somebody else wants to describe it a different way then being my guess, but I’m a value investor.

Bill Brewster:
The thing that I found-

Tobias Carlisle:
I’m a deep value investor.

Bill Brewster:
Well the thing that I found interesting from talking to you, I didn’t know that your second and correct me if I’m wrong, but in your portfolio the second strongest factor is quality.

Tobias Carlisle:
Right. And that’s just because I like everything. My objection is just a return on invested capital just because it tends to be highly mean reverting. But I like cash flows on cash flows or balance sheet cashflow buying back stock, all indicia of quality I agree with of course you want to learn that stuff. Actually if you’re going to ask about things that should be joined at the hip, I think quality and growth as quality and value are joined at the hip. I don’t see how you get value without quality. You got something that’s cheap on all of its ratios. Who cares? I want something that I want to own cheap on those ratios. That to me is the definition of kind of value investing. Something that you do want to own at a low price.

Jake Taylor:
I wonder if there is another kind of z-axis to this to help maybe us figure this out? What about one is a version of looking backwards that would be the kind of more academic ‘value and growth’ and then one is kind of more looking forward, I’m making projections about the future. I wonder if we can come up with a smart way to rename them based on the fact that there’s sort of time differences.

Tobias Carlisle:
I’m still making a prediction about the future that I am saying, I think that these things, I think there’s going to be a mean reversion, although that [inaudible 00:25:46] paper that I put in that I was surprised by that when it came out. That was a new analysis. That’s in fact is from scratch the [inaudible 00:25:53] from scratch. What they showed is that the earnings tend to deteriorate over the holding period for value stocks. And that’s been true over the full dataset. I was a little surprised by that because the way that the data is usually analyzed, it looks like the portfolio is getting cheaper and cheaper, and the reason that has been that people have ascribed to that, including me is mean reversion in the underlying earnings. But it turns out that that’s not right. I don’t know if that’s exactly what’s happening in my portfolios because I tend to own things.

Tobias Carlisle:
I own Berkshire, I own Markel, I own Schwab, they’re all growing, they’re all going to be bigger. The rate of growth across my portfolio is 11% top line. Sorry, sorry, let me be clear. 5% top line, 11% bottom line, because they tend to buy back a lot of stock. So there’s growth in the portfolios, but I’m not buying on the basis of that growth. I’m assuming there’s going to be some growth and I think it’s a bonus in over five years. That’s very material growth. But in the short term, who knows? I just think they’re mispriced. I think they’re below market and they’re trading below market and they’re worth more.

Don’t Write Off Warren Buffett

Tobias Carlisle:
I’m all for a different name for it, but I don’t think there’s a good one. I think deep value versus franchise value or Buffett style value is pretty good distinction. We’re going to cross over sometimes too. I mean Apple was in my screens when Buffett bought. Berkshire’s in my screens, I was surprised that he didn’t buy it this time around, but I guess he’s got other things going on.

Bill Brewster:
It’s not over, man. It’s not over. I mean, look, if he has changed his mind on what he thinks the potential path of outcomes are, he’s got a shot right now to buy it at not that much higher. I mean, people have fully thrown in the towel on Buffett, which-

Tobias Carlisle:
Astonishing.

Bill Brewster:
I mean even I did according to some people, I will let those people know that my new money has been going into Berkshire over everything else. So I am not.

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