The conundrum continues
The two schools of thought and the disparity of the relative performance of both investment styles continues to be a point of discussion amongst investors.
As equity markets continue to rally in all major regions, are we approaching a point where the merits of Value investing (and its basis of fundamental analysis) are going through a structural change and will be less important going forward? Or will we eventually realise that the emperor is not wearing any clothes and the piper needs to be paid?
Value portfolio managers pride themselves of finding diamonds in the rough.
Companies whose business models are not being reflected in the valuation of their equity at certain points in time, and as management deliver improved financial performance (usually through higher earnings and increased dividends) the value of the companies increase.
Value investing usually encompasses a less volatile approach but also has less capital upside potential, as these businesses tend to be more mature.
Growth portfolio managers are focused on companies that are expected to grow, usually via revenues, volume growth or even profits. Growth is the priority. Companies aspire to get big or they shrink on the vine with earnings reinvested in the business in order to facilitate further growth. Growth-focused companies usually offer higher upside and as a result could be seen as carrying higher risk commensurate with the perceived higher reward, and are more suited to investors with higher allocations to risk and generally longer investment timeframes.
These two styles have become the topic of much discussion as Growth stocks’ price to earnings ratios continue to expand, while Value stocks underperform as the chart below illustrates. Societe Generale illustrates three styles, but it’s the Value and Growth lines that I would like to bring to your attention.
Source.: Societe Generale Cross Asset Research/Equity Quant. Factset, FTSE.
There is another style of manager that aims to be a blend of both Value and Growth, who invest in both companies. This strategy is known a GARP, Growth At a Reasonable Price, which has a strong awareness of traditional value indicators while focusing on growth companies.
This year, the global COVID-19 pandemic has accentuated the disparity of the styles with Value stocks underperforming Growth by a wide margin.
Should investors be questioning whether Value investing still relevant?
Liquidity is always linked to price. In normal markets, when a price gets too high, buyers tend to disappear. With central banks providing seemingly endless liquidity and governments going out of their way to spend their way out of this crisis, has the disparity in Value vs Growth become too extreme?
Central banks have been buying government and corporate issued debt with little sensitivity to price, ensuring that underlying asset prices have little ability to sell-off and incur loses. However, it’s my view that asset values must be allowed to fall, otherwise you encourage people to bet on ever-increasing prices.
Poorly-managed companies should be able to go broke.
Industries with excess capacity need to shrink, while those who are exposed to positive structural change in a post-COVID economy should expect to be rewarded.
In many respects, the rewards of Growth investing experienced over the past 12 months can be justified, as 20th century businesses globally struggle with the new norm. Traditional brick-and-mortar retailers saw business move swiftly to companies with a significant online platform. Tech companies servicing the new economy became market darlings, while traditional sectors like energy were discarded.
If there was one comparison that highlights this extreme in Australia, its Afterpay (APT.ASX), Origin Energy (ORG.ASX) and AGL (AGL.ASX).
Origin and AGL have combined sales of just over $26bln ($13.15bn & $12.16bn) according to Factset, with a combined EBITDA of $3.47bn ($1.17bn & $2.3bn).
Afterpay, by comparison, has sales of $519mln and is not yet profitable, yet when comparing market capitalisations, Afterpay comes in at $29bln, which is $16bln more than AGL and Origin combined.
According to Factset, Afterpay is on a PE of 421x FY21E while AGL is on 14.7X and Origin 15.6X.
No doubt the value the market sees in Afterpay is due to a structural shift, as the “buy now, pay later” thematic continues to make inroads into the juggernaut that was the domain of the big banks. Structural change will impact many industries in this post-COVID world, and there will be great opportunity for investment with beneficial social, environmental and financial returns.
Prospects across the real economy in sectors like industrials, energy, resources, waste, health, telecommunications and food can be found as Value managers seek out businesses that are tangible and real.
When I look at growth, even if I take a medium to long term view, I always ask myself, “What would you pay for any stock if it was not listed?” i.e. if there was no perceived liquidity not inherent in the asset’s price.
Being listed comes with a lot of noise that impacts the perception and influences what a company is worth.
The discussion on the rewards from both Value and Growth investing will continue to generate much interest. What is clear, is that the both styles have significant value to add to a balanced portfolio and investors should consider both styles and the companies they cover when building their portfolios.
The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.