In his latest Q3 Earnings Call, Rich Pzena provides some research that shows that cheap stocks can be quality stocks too. Here’s an excerpt from the call:
We human beings are irrational decision makers. It’s not just my opinion. Decades of behavioral economics research and several Nobel Prizes have been handed out in support of this conclusion. We simply tend to make biased judgments. Sometimes out of recent experience, sometimes out of a hard-wired predisposition towards loss of version. The evidence is powerful. We, humans, are simply irrational economic actors.
The truth is effectively the path platform upon which value investing is built. Value investors capitalize on the realization that human biases impede rational decision making, and the resulting mix/priced assets are available for those willing to systematically override their biases and apply rational economic analysis for their decisions.
Let’s consider the choice of which asset class offers the most attractive future return profile today. Using our estimated normalized earning yield as a metric, the cheapest quintile of the 2000 largest global stocks offers a yield of more than 13%. Compare that to the estimated normalized earnings yield of the full universe of global stocks at just over 6%, and treasury bonds and Eurobonds each offering yields of just 2% or less. And yet, current sentiment, investment literature, stock price momentum all would have one believe that the better choice is to be found among assets with lower projected earnings yields.
The rational actor would obviously prefer the double-digit return opportunity embedded in the cheapest stocks. Let’s consider one of the most common current arguments for avoiding the cheapest stocks today. Namely, I prefer quality – or – okay. So let’s look at the facts.
The cheapest quintiles of both U.S. and non-U.S. stocks have 10-year average revenue growth rates of 6% and 8% and 10-year average returns on equity of 17% and 13% respectively. By any analytic frame, I think it’s fair to say that this is a fertile hunting ground for quality businesses.
Let’s also consider the near-term projected earnings of the cheapest stocks. Wall Street analysts are projecting value stocks to grow their earnings at more than 20% compounded annual growth rate through 2023, a higher rate than projected by analysts for growth stocks. And we can buy these growing high-quality value stock businesses for prices at 60% or more discounted to their growth gathering.
A message in conclusion is clear. We think the value cycle is still in its early stages. There will, no doubt, still be bumps in the road ahead as there always are but to ignore the data is to fall prey to the irrational decision maker spate of suboptimal outcomes. You can count on us to always stay true to our value discipline and therefore offer a counterbalance to this all – to human reality.
You can read the full transcript here:
Rich Pzena Q3 2021 Earnings Call -Seeking Alpha
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