2022 will be a challenging year for most asset classes and investment styles. With a bit of foresight, however, silver linings can also be seen on the stock market horizon, despite the budding recession. Because following the recent valuation excesses around non-profitable technology stocks, Cryptocurrencies & Co. many investors are coming to their senses. Instead of hopes and fantasies, hard facts count when evaluating companies and their shares. In order to take advantage of these new opportunities, however, a special craft is required that has almost died out during the growth stock gluttony of recent years: value investing.
The reason for the decline of the value profession over the past decade, which culminated in the debauchery that followed the first wave of the coronavirus, is easily explained: During the Teslas and Carvanas of this world always soared to new heights, undervalued stocks without the right “story” underperformed as most investors jumped on the price rockets. Even if the past two years marked the zenith, this was a long-lasting, gradual process. The result? Today there are hardly any professional investors under the age of 40 who have experienced a full value cycle in their job.
Most people only know the outperformance of value versus growth stocks from hearsay. Much more critical, however, is that hardly anyone has mastered the classic value investing analysis.
Many growth investors recognize their excessive optimism
History doesn’t repeat itself, but it rhymes. And just like following the dot-com bubble, the tide is likely to turn with the end of excess valuations and the end of the negative interest era. Gone seem to be the days when a hundred times the profits expected in a few years were paid without batting an eyelid. There are good reasons for this reversal – above all, many investors have returned to their senses and the end of negative interest rates. The structural causes higher inflation will lead to permanently higher interest rates in the coming years. However, because the profits of many growth companies lie far in the future, rising interest rates lead to higher discount rates and thus to lower valuations and price levels.
On the other hand, word of the value comeback gets around quickly. Value investor legend David Einhorn recently stated in a Bloomberg interview: “Most value investors have been pushed out of the business. […] Nobody knows anymore what actually happens to companies. […] Nobody knows what something is worth.” Einhorn’s statement may be exaggerated, but it is fundamentally correct. As a value investor, you can feel lonely these days. Anyone who is concerned with the consequences of this development should first be familiar with the two common definitions of value investments:
First, there is the Benjamin Graham version, popularized in the 1930s, which involves careful analysis of balance sheets and companies to determine if there is a margin of safety in the valuation, even if the price changes Contrary to expectations, the cheaply valued share did not recover. Proponents of this craftsmanship as an investment style include Joel Greenblatt and Walter Schloss and also Warren Buffett (at least before Berkshire Hathaway grew too big to practice this in its purest form).
Second, there is the “Fama & French” version, popularized by economists and Nobel Prize winners Eugene Fama and Kenneth French, who empirically demonstrated that stocks that were cheap by price-to-book tend to, over time, to outperform the broad stock market
In practice, classic Benjamin Graham value investors prefer concentrated, actively managed funds, while “Fama & French” value investors tend towards broadly diversified, automated factor portfolios. The first style is a combination of investment philosophy and analytical working methods, the second a quantitative decomposition that works with fixed assumptions. When we talk regarding value investing, we mean classic value investing, i.e. the investment philosophy by the young Warren Buffettonce a student of Benjamin Graham and Walter Schloss.
Deep mispricings in value stocks
If you look for the remaining fundamental value investors, you will be disappointed: A number of professional value supporters have given up this investment style in recent years. As a result, only a few investors analyze companies meticulously from a fundamental point of view, which has led to longer-lasting and deepening mispricings in recent years. The bottom line is this is an opportunity of the century for value investors.
