Value investing is poised to rise from the dead
Warren Buffett, the greatest investor of all time, has announced his retirement. Fellow value investors are in a state of shock. Unfortunately, they have more serious problems to consider. For years, their favoured investment style has been out of fashion. Clients have lost patience. In a world where the US stock market index has delivered consistently outsized returns, low-cost funds that passively track an index seem a no-brainer. Yet the prospects for value investors have always been brightest when the rest of the world loses faith.
Over the very long run, buying equities at relatively cheap valuations has worked out well. Economists Eugene Fama and Ken French define value as a low ratio of share price to book value. Using this measure, US value stocks have beaten growth stocks, which have high price-to-book ratios, by 2.5 percent a year since 1926. Value has also outperformed in most other overseas markets, according to the UBS Global Investment Returns Yearbook compiled by Elroy Dimson, Paul Marsh and Mike Staunton. Its luck ran out, however, on the eve of the global financial crisis. Between 2007 and 2020, growth beat value. The latter recovered some ground in 2020 but fell back again after the “Magnificent Seven” big technology stocks took off in late 2022.
It is important to note that price to book is not the metric contemporary value investors rely upon. Warren Buffett’s partner, the late Charlie Munger, taught him to consider a firm’s competitive position – what the Oracle of Omaha called the “moat.” If a business consistently earns above-average returns on capital, investors can safely buy its shares at a premium multiple to the rest of the market. Furthermore, the balance sheet value of a company’s assets is not a reliable measure of value, since it excludes many intangible assets such as research and development. Share buybacks and acquisitions further distort accounting book value.
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