Written by Rishi Kulkarni
Warren Buffet is known as the Oracle of Omaha for a reason. Over the past 70 years, his intensely disciplined approach to value investing had turned him into one of the most successful investors in the world; the investment community very closely follows his investment decisions and market outlooks. However, things have changed since the 2008 financial crisis. A low interest rate environment has allowed growth stocks to offer better returns than value stocks over the past 12 years.
Value investing offers attractive returns in the long term, with time frames ranging anywhere from one year to 20+ years (Warren Buffet has held Coca Cola since 1988). However, in the past 12 years, the Russell 3000 Growth Index has returned about 490% while the Russell 3000 Value Index has returned a more modest 144%. Growth investing strategies look for stocks that are poised to grow faster than the rest and typically focus on companies that reinvest all of their earnings for rapid growth. As a result, growth stocks like Amazon and Apple are extremely expensive, which means that they are priced at relatively high multiples of their earnings; there is no telling when the positive sentiment around them could stop. Low interest rates have defined the economy for the past 12 years and are likely to continue doing so, considering the recent policy changes from the Fed. This is good news for growth investors, as low interest rate environments generally help growth stocks by increasing the future value of their cash flows. However, this positive outlook only holds up in the short term. It is impossible to predict the interest rate environment 20 or 30 years into the future, and by that time, value stocks may have recovered to match the returns of growth stocks. Growth stocks have been propelled by unsustainable trends that are bound to end sometime in the future. Additionally, a company can’t maintain rapid growth year after year in the long term. Although there is a strong case for buying growth stocks in the short term, it would be unreasonable to rely on growth stocks to provide superior returns.
Value investing is one of the oldest, most well-known investing strategies that is still used today. I spoke with Jaro Van Diepen, one of the portfolio managers for the Investment Analysis Group here at Stern, to learn more about what value investing is. Jaro explained that value investing aims to find companies that are trading at a discount to their intrinsic value, then buy and hold these stocks until the market catches up with their valuation. One might ask what guarantee there is that the market will ever recognize the intrinsic value of a company; Jaro explained how IAG looks for catalysts for their investments, which are specific factors such as new products or a change in management that are expected to elicit a market reaction. Overall, value stocks are much safer investments than growth stocks as they are typically more rooted in reality.
It would be incredibly premature to declare value investing dead after only 12 years of meager returns. While it is true that value investing has had weaker performance in recent years, is it fair to say that is a trend that will continue for the next 20 years? Additionally, value investing has still offered better returns over the past 30 years. The risk profile and stability of value investments are simply unmatched by growth stocks. The volatility associated with the dependence on economic trends and rapid growth makes growth stocks unsustainable as long term investments. As for the short term, seasoned investors would know that growth stocks and value stocks outperform each other cyclically; it is rarely the case that one of the two strategies is “dead” when it is underperforming. Investors looking to preserve their capital and maximize returns in the long term should not turn away from value investing. Although the strategy is currently underperforming, investors who have done proper due diligence should be confident in the profitability of their value stock picks. Value investing is not “dead” in any sense of the word.