Over the last few years, traditionally defined “Value” stocks have continued to get cheaper while “Growth” oriented cos have done very well. The divergence is stark and is now prompting questions whether Value Investing is dead.
The categorization of stocks between “Growth” and “Value” is erroneous. Anything that is low PE multiple and out of favour with markets is typically labelled “Value” and anything with high multiples and fast growth is labelled “Growth”. Many stocks that are growth darlings today were value stocks some time ago and vice versa. For example, Power utility stocks were designated as growth stocks in 2008 while Specialty Chemicals were designated as Value. Their categorizations today would be the inverse.
There are rationale reasons why traditionally defined “value” stocks have had a very poor run over the past few years
- India has had very poor economic growth relative to potential since 2015 and this has led to increased interest in the pockets that have demonstrated earnings growth. Rising stock prices create more demand pushing prices even higher till the bubble is pricked
- Many PSUs, typically classified as value stocks, have suffered because the Govt. has sold its stake at any price and thus not acted as a promoter who cares about value. The Govt. has also used surplus capital of cash-rich PSUs to meet divestment goals thus questioning capital allocation discipline and independence of PSUs
- Coal-based Assets, where dividend yields are at present higher than bond yields, are facing headwinds of ESG risks. Many fund managers now operate within ESG constraints out of mandate and hence do not want to buy these stocks hence reducing demand for them. A secular trend towards clean energy reduces the value of these companies as there is a steep decline in terminal value assumptions (where typically most of the value resides)
- PSU Banks are a melting ice cube in terms of competitiveness as Private Banks continue to eat their lunch and target their best customers. The perceived margin of safety in most PSU Bank stocks has turned out to be a mirage
And there has been some bad luck due to actions of developed world Central Banks
- Traditional value investors obsess more than others about “margin of safety” – the holy grail of Investing
- However, Central Bank intervention has resulted in interest rates being suppressed for much longer than anyone would have rationally expected. Declining interest rates have justified higher multiples of Growth stocks as lower discount rates – all things remaining the same- justify higher valuations for rapidly growing companies.
- And hence, the mean reversion of valuation multiples of growth stocks has not happened; rather, their multiples have been pushed even higher thus widening their outperformance with Value.
Value investing is not dead. Rather, all successful investing is essentially value investing. Even when one is paying a high multiple for a stock, it could be “Value investing” because the competitive position, expected pace of growth and ROCE may justify that valuation.
- However, one cannot buy a franchise at any price because valuation multiples will eventually trend lower as margins/growth in most businesses tend to reduce over time.
- Inversely, one must not buy an asset trading cheap without probing whether the price reflects risks of deteriorating prospects (“value trap”)
Nietzsche had a great line “… the right way, the correct way, and the only way, it does not exist.” Investors have to adapt to the changing market context else we risk being left behind.