In his latest article Aswath Damodaran discusses four reasons why value investing hasn’t worked over the past decade and whether it’s time for value investors to consider the possibility that it’s time to change the way we practice value investing. Here’s an excerpt from the article:
The attempt to explain what happened to value investing in the last decade (and during COVID) is not just about explaining the past, since the rationale you provide will inform whether you will continue to adhere to old-time value-investing rules, modify them to reflect new realities or abandon them in search of new ones. In particular, there are four explanations that I have heard from value investors for what were wrong during the last decade, and I will list them in their order of consequence for value investing practices, from most benign to most consequential.
1. This is a passing phase!
Diagnosis: Even in its glory days, during the last century, there were extended periods (like the 1990s) when low PE and low PBV stocks underperformed, relative to high PE and high PBV stocks. Once those periods passed, they regained their rightful place at the top of the investing heap. The last decade was one of those aberrations, and as with previous aberrations, it too shall pass!
Prescription: Be patient. With time, value investing will deliver superior returns.
2. The Fed did it!
Diagnosis: Starting with the 2008 crisis and stretching into the last decade, central banks around the world have become much more active players in markets. With quantitative easing, the Fed and other central banks have contributed not only to keeping interest rates lower (than they should be, given fundamentals) but also provided protection for risk taking at the expense of conservative investing.
Prescription: Central banks cannot keep interest rates low in perpetuity, and even they do not have the resource to bail out risk takers forever. Eventually, the process will blow up, causing currencies to lose value, government budgets to implode and inflation and interest rates to rise. When that happens, value investors will find themselves less hurt than other investors.
3. The Investment World has become flatter!
Diagnosis: When Ben Graham listed his screens for finding good investments in 1949, running those screens required data and tools that most investors did not have access to, or the endurance to run. All of the data came from poring over annual reports, often using very different accounting standards, the ratios had to be computed with slide rules or on paper, and the sorting of companies was done by hand. Even into the 1980s, access to data and powerful analytical tools was restricted to professional money managers and thus remained a competitive advantage. As data has become easier to get, accounting more standardized and analytical tools more accessible, there is very little competitive advantage to computing ratios (PE, PBV, debt ratio etc.) from financial statements and running screens to find cheap stocks.
Prescription: To find a competitive edge, value investors have to become creative in finding new screens that are either qualitative or go beyond the financial statements or in finding new ways of processing publicly accessible data to find undervalued stocks.
4. The global economy has changed!
Diagnosis: At the risk of sounding cliched, the shift in economic power to more globalized companies, built on technology and immense user platforms, has made many old time value investing nostrums useless.
Prescription: Value investing has to adapt to the new economy, with less of a balance sheet focus and more flexibility in how you assess value. Put simply, investors may have to leave their preferred habitat (mature companies with physical assets bases) in the corporate life cycle to find value.
From listening to value investors across the spectrum, there does not seem to be a consensus yet on what ails it, but the evolution in thinking has been clear. As the years of underperformance have stretched on, there are fewer value investors who believe that this is a passing phase and that all that is needed is patience. There are many value investors who still blame the Fed (and other central banks) for their underperformance, and while I agree with them that central banks have sometimes overreached and skewed markets, I also think that this belief has become a convenient excuse for not looking at the very real problems at the heart of value investing. Especially after the COVID experience, there are at least some value investors who are willing to consider the possibility that it is time to change the way we practice value investing. In my next post, I will look at some of these changes.
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