25 Nov 2020
Value versus growth – two eyes are better than one
Value or growth? Harold takes a look at what should be focussed on for successful investing.
A vaccine boost for markets has reignited chatter of a sustained rotation back to neglected value stocks, but also distant echoes of the Nifty Fifty fallout in the 1970s. It even throws the mind back to the bursting of the tech bubble early in the new millennium. Yet views are mixed. Ted Aronson, the founder of value-driven AJO Partners from Philadelphia, summed it up beautifully in a final thought to shareholders: “There is a future for value investing; sadly, the future is unlikely to arrive fast enough – for us”. With every dollar invested in the Russell 1000 Growth Index quadrupling over the last decade, compared to Value which was just doubling, we can almost feel his pain, bruised and battered on the streets, as Springsteen might have put it.
But what do these terms ‘value investing’ and ‘growth investing’ really mean? Contrary to some popular opinion, value investing is not about identifying ‘cheap stocks’ based on a simple balance sheet or income filters such as low P/E or P/BV. That might have been the case decades ago, but today, both earnings and book value are deceptive as inputs to economic value calculations – see a great book by David Holland and Bryant Matthews: Beyond Earnings for a deeper discussion of the differences between accounting and economic-financial statements.
A more accurate characterisation of a value investor is that she pays primary attention to a company’s ‘assets in the ground’. These can be both tangible and intangible (patents, brand value etc.). They represent the accumulation of management’s previous investment decisions, adjusted for economic wear and tear, and revaluation of non-wasting assets. In essence, the value investor is a judge, delivering her verdict on the longer-term value of existing assets relative to their current stock market value, using Buffett’s mantra that in the short-term the market is a voting machine, but in the long-term a weighing machine. Thus, sophisticated value investing is ultimately about the weight of today’s evidence.
"All good investing boils down to insight on cash flows, be they from existing assets or potential growth investments."
Conversely, the growth investor’s primary attention is on the future rather than past corporate investment decisions. It is an exercise in the imagination, a journey into the known unknowns. It seeks to discern the full potential for companies that will be driven by prospective changes to consumer tastes, the market impact of new disruptive technologies, and sheer management innovation. Growth investing is thus about assessing future scenarios and business investment, with their implications for valuation. Again, simple ratios, this time high P/E or P/BV, are not necessarily relevant.
The critical point is this. Despite the rather different lenses of value and growth investors, with their individual focus on existing or growth assets, both are ultimately trying to identify the same thing – the underlying economic value of companies. All good investing boils down to insight on cash flows, be they from existing assets or potential growth investments. The investment philosophies are not mutually exclusive.
It is a fair point that, in the kingdom of the blind, the one-eyed are kings. However, it is also true that two eyes are better than one. Investment is best done with attention paid to both growth and value. They are not irreconcilable, as a naive interpretation of indices might have us believe.
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