What does value investing have in common with Forrest Gump?
The last decade or so has not been kind to value investors.
Not only are we that much older, we’re that much greyer as a result of performance that has left even the most hardened of us battered, bruised and battle-scarred.
Value investing involves buying stocks that are undervalued (cheap relative to their true underlying value) in the hopes that share prices will recover to reflect this true value. This is in contrast to growth investors who pay focus instead on the potential for growth in a company’s earnings rather than its valuation.
Value’s returns are the worst they’ve ever been
History tells us that value has been an enduring investment style over time and outperforms growth more often than growth outperforms value. But last few years have marked the longest and deepest underperformance of value versus growth seen in recent history.
Figure 1: How value investing has performed compared to growth investing over any 10-year period since 1936
Source: SIM analysis, Professor Fama’s data library, Tuck University, as at 31 December 2019. Rolling 10-year total return difference: Fama-French HML (value vs. growth).
Past Performance is not a guide to future performance and may not be repeated. For illustrative purposes only and not to be considered a recommendation to buy or sell.
When I look at a chart like this, I think one of two things. Either it’s different this time for some reason or this is the buying opportunity of a generation, relative to other equity investments investors can make right now.
So which is it?
I don’t believe value investing has become obsolete. As a style of investing, value isn’t fundamentally broken; it’s a human phenomenon that hasn’t changed. Value investing is still about constantly exploiting the irrational behaviour of emotional investors; being brave when investors are fearful and wary when they are ebullient.
When I look in the markets or read the news, I see humans behaving like humans everywhere. I don’t think we’ve become radically more rational or less emotional.
So if humans haven’t changed and value investing is still relevant, is this the buying opportunity of a generation?
Value stocks are as beaten up as they’ve been in nearly 100 years; investors have fled to what they perceive as to be the safe harbour in the current value storm: growth stocks.
Is the “safe” harbour the best place to be in a storm?
But what if the port is the worst place to be? What if it’s better to be bobbing out at sea with a bit of volatility rather than risk being hammered against the harbour walls during the storm?
Look at what happened to Forrest Gump and Lieutenant Dan in the award-winning 1994 film “Forrest Gump” starring Tom Hanks. The duo join the shrimping industry with Gump’s newly-purchased shrimp boat. But the competition is tough and their endeavours are highly unsuccessful; their nets pull up only old shoes and toilet seats.