GMO: Deep Value Really Undervalued

In their latest episode of the VALUE: After Hours Podcast, Morris, Taylor, and Carlisle discuss GMO: Deep Value Really Undervalued. Here’s an excerpt from the episode:

Tobias: Do you want me to do the GMO paper? There’s just one interesting factoid from the paper that I just wanted to bring.

Jake: Yeah.

Alex: Yeah.

Tobias: I thought it was kind of interesting. So, this is the quarterly letter and they’re explaining the deep value. They say the deep value is very, very cheap. They divide the universe into five quintiles. So, quintile is 1/5th and then they rank them from one to five, where one is the most expensive. That’s all the growthy type stocks. And then, the fifth is the cheapest, so the value-type stocks. And then, they looked at their relative valuations to their own histories. And so, the most expensive stocks, even though they’re off a lot, they’re still trading in the 88th percentile of overvaluation, which I think is amazing. The second quintile was in the 90th percentile of overvaluation.

Jake: [crosstalk] This is the most expensive we’re talking about and working our way down?

Tobias: The most expensive is in the 88th percentile of overvaluation.

Jake: Okay.

Tobias: The second quintile was in the 90th percentile of overvaluation. The third quintile was in the 97th percentile of overvaluation. So, that’s the market, probably. The fourth quintile, so this is the second value bucket. This is in 70th percentile of overvaluation. But if you get down to the cheapest bucket, it’s in the fourth percentile relative to its own history. So, what you’ve seen is huge. I’ve been talking about the spread, like this massive spread for a while now. They peaked at the end of September. I think it came in in October for the first time and you can see that in this data are a little bit. Basically, what GMO is saying is that deep value is the only place that’s really undervalued. Yeah.

Jake: See, after I read that, I went and looked a little bit, I was trying to dig into some of my– If I cannot confirm that anywhere in other data– And one of the places I looked was the ETF RZV, which is the small cap value, it’s just a plain vanilla small cap value. I’ve owned it at different points in the past. When I looked at it, it was at 8.6 PE trailing and 0.95 price to book, which to me is like a normal price for small value. It’s probably around one times price to book typically. Maybe a little bit more than that. But I’ve bought it at times where it was down at a half of price to book. So, that’s 2x from where– I know, I’ve purchased it before. So, that’s doesn’t quite square with that fourth percentile cheapest cheap bucket in my mind.

One thing that was interesting was that the ROE on the RZV was actually 12.5%, which I thought was quite a bit higher than I would have guessed. That’s a lot higher quality. So, maybe that’s part of it. I don’t know. Clearly, we’re looking at different data slices somehow. But to me, it didn’t seem quite as cheap as I would have expected based on GMO’s observation.

Tobias: Yeah, how have they determined the value? Oh, I’ve just lost the–

Jake: Are they probably use some kind of multifactor or multi-measurement value–?

Tobias: That makes sense. [laughs]

Alex: If you want something to be optimistic about it, I remember a Golden report a few years ago that said we’re at the 99th percentile in terms of valuation. You said the middle bucket’s 97 now, right? So, we’re getting cheaper.

Jake: So, you’re telling me there’s a chance.

Tobias: [laughs] It’s funny how little it’s moved, honestly. It’s funny to go and look at it and see. I feel the market, it’s been in drawdown all year long. At various stages, we’ve been down 20% or so. I don’t check it that often. So, I went back in and had a look and I was like, “Oh, no, it’s hardly moved. It’s hardly off,” because it bounce so much from that October low.

Jake: Well, if you’re using earnings– I don’t feel that the fundamental has rolled over to keep at a similar valuation level, the ratio? I don’t know. You’re right though. It doesn’t feel this super bomb-out, certainly yet.

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