Value vs Growth Investing : Latest Memo from Howard Marks
What is Value Investing?
Value investing is one of the key disciplines in the world of investing. It consists of quantifying what something is worth intrinsically, based primarily on its fundamental, cash flow-generating capabilities, and buying it if its price represents a meaningful discount from that value.
Importantly, value investors recognize that the securities they buy are not just pieces of paper, but rather ownership stakes in (or, in the case of credit, claims on) actual businesses.
Now, determining this value in practice is quite challenging, and the key to success lies not in the ability to perform a mathematical calculation, but rather in making superior judgments regarding the relevant inputs. Simply put, the DCF method is the main tool of all value investors in their effort to make investment decisions based on companies’ long-term fundamentals.
Value vs. Growth
Over the last 80-90 years, two important developments occurred with regard to investing style. The first was the establishment of value investing, as described above. Next came “growth investing,” targeting a new breed of companies that were expected to grow rapidly and were accorded high valuation metrics in recognition of their exceptional long-term potential.
The two approaches – value and growth – have divided the investment world for the last fifty years. They have become not only schools of investing thought, but also labels used to differentiate products, managers and organizations. Based on this distinction, a persistent scoreboard is maintained measuring the performance of one camp against the other. Today it shows that the performance of value investing lagged that of growth investing over the past decade-plus (and massively so in 2020), leading some to declare value investing permanently dead while others assert that its great resurgence is just around the corner. My belief, especially after some deep reflection over the past year – is that the two should never have been viewed as mutually exclusive to begin with.
As Buffett put it, “We don’t consider ourselves to be value investors. . . . Discounted cash proceeds is the appropriate way to value any business. . . . There is no such thing in our minds as value and growth investing.” It just so happened that considerable opportunity existed for them in the cigar butt arena at the time they operated – especially considering that both started with relatively small amounts of money with which to invest – so that’s what they emphasized
When I consider this new world, I think fundamental investors need to be willing to thoroughly examine situations – including those with heavy dependency on intangible assets and growth into the distant future – with the goal of achieving real insight. However, this is, to an extent, antithetical to the value investor’s mentality. Part of what makes up the value investor’s mindset is insistence on observable value in the here-and-now and an aversion to things that seem ephemeral or uncertain. Many of the great bonanzas for value investors have come in periods of panic following the bursting of bubbles, and this fact has probably led value investors to be very sceptical of market exuberance, especially when concerning companies whose assets are intangible. Scepticism is important for any investor; it’s always essential to challenge assumptions, avoid herd mentality and think independently. Scepticism keeps investors safe and helps them avoid things that are “too good to be true.”
But I also think scepticism can lead to knee-jerk dismissiveness. While it’s important not to lose your scepticism, it’s also very important in this new world to be curious, look deeply into things and seek to truly understand them from the bottom up, rather than dismissing them out of hand. I worry that value investing can lead to the rote application of formulas and that, in times of great change, applying formulas that are based on past experience and models of the prior world can lead to massive error.
But by far the most important intention of this memo is to explore the mindset that I think will prove most successful for value investors over the coming decades, regardless of what the market does in the years just ahead. It’s important to note that (a) the potential range of outcomes for many of today’s companies is very wide and (b) there are considerations with enormous implications for the ultimate value of many companies that do not show up in readily available quantitative metrics. They include superior technology, competitive advantage, latent earning power, the value of human capital as opposed to capital equipment, and the potential option value of future growth opportunities. In other words, determining the appropriateness of the market price of companies today requires deep micro-understanding, and that makes it virtually impossible to opine on the valuation of a rapidly growing company from 30,000 feet or by applying traditional value parameters to superficial projections. Some of today’s lofty valuations are probably more than justified by future prospects, while others are laughable – just as certain companies that carry low valuations can be facing imminent demise, while others are just momentarily impaired. The key, as always, is to understand how today’s market price relates to the company’s broadly defined intrinsic value, including its prospects.
- First, the apparent ease of predicting traditional Company A’s future can be quite deceptive – for example, considerable uncertainty can exist regarding its risk of being disrupted by technology or seeing its products innovated out of existence. On the other hand, while Company B is more nascent, its products’ strength and traction in the marketplace may make success highly likely.
- Second, as noted earlier, if conclusions regarding Company A’s potential can easily be reached by a finance student with a laptop, how valuable can such conclusions be? Shouldn’t a deep understanding of a company’s qualitative dynamics and future potential be a greater source of advantage in making correct forecasts than data which is readily available to all?
Value investing is thought of as trying to put a precise value on the low-priced securities of possibly mundane companies and buying if their price is lower. And growth investing is thought of as buying on the basis of blue-sky estimates regarding the potential of highly promising companies and paying high valuations as the price of their potential. Rather than being defined as one side of this artificial dichotomy, value investing should instead consist of buying whatever represents a better value proposition, taking all factors into account.
Much of value investing is based on the assumption of “reversion to the mean.” In other words, “what goes up must come down” (and what comes down must go up). Value investors often look for bargains among the things that have come down. Their goal, of course, is to buy under-priced assets and capture the discounts. But then, by definition, their potential gain is largely limited to the amount of the discount. Once they have benefitted from the closing of the valuation gap, “the juice is out of the orange,” so they should sell and move on to the next situation.
To end, I’ll pull together what I consider the key conclusions:
- Value investing doesn’t have to be about low valuation metrics. Value can be found in many forms.The fact that a company grows rapidly, relies on intangibles such as technology for its success and/or has a high p/e ratio shouldn’t mean it can’t be invested in on the basis of intrinsic value.
- Many sources of potential value can’t be reduced to a number. As Albert Einstein purportedly said, “Not everything that counts can be counted, and not everything that can be counted counts.” The fact that something can’t be predicted with precision doesn’t mean it isn’t real.
- Since quantitative information regarding the present is so readily available, success in the highly competitive field of investing is more likely to be the result of superior judgments about qualitative factors and future events.
- The fact that a company is expected to grow rapidly doesn’t mean it’s unpredictable, and the fact that another has a history of steady growth doesn’t mean it can’t run into trouble.
- The fact that a security carries high valuation metrics doesn’t mean it’s overpriced, and the fact that another has low valuation metrics doesn’t mean it’s a bargain.
- Not all companies that are expected to grow rapidly will do so. But it’s very hard to fully appreciate and fully value the ones that will.
- If you find a company with the proverbial license to print money, don’t start selling its shares simply because they’ve shown some appreciation. You won’t find many such winners in your lifetime, and you should get the most out of those you do find.
I once asked a well-known value investor how he could hold the stocks of fast-growing companies like Amazon – not today, when they’re acknowledged winners, but rather two decades ago. His answer was simple: “They looked like value to me.” I guess the answer is “value is where you find it.”
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You may find the full article / memo on below Link :
Latest memo from Howard Marks: Something of Value <source : Oaktreecapital.com>
Howard Marks Says Fed Is Pushing Investors Into Risky Assets
It is hard to draw a line to distinguish between ” Value or Growth” investing, we could find growth in value stocks and vice versa. We may start to see value emerge when price of growth stocks drops to an “unreasonable low” level due to certain issues / event, which would temporarily affect the price.
Both value and growth stocks investing will still have many “pitfalls “and investors may ended up being caught in “value trap and growth trap (delusion)” in keep chasing the "value" without in-depth analysis of the business and fundamental of that company..
<Image credit : bbc.com>