A recent article from Pzena Investment Management shares insights regarding value investing and the likelihood that it will emerge from its long period of underperformance.
Here are some key takeaways from the article:
The article argues that value is a “timeless and logical approach” to estimating the long-term value of a business that involves buying stocks “when their share prices have dropped for reasons we believe are temporary.”
“To us, value is simply arithmetic that entails buying something cheap relative to the present value of its future cash flows, which we measure using normal earnings. Value is not a factor.”
Pzena conducted an analysis of 14 U.S. recessions (dating back to the Great Depression) and 8 recessions in Japan since 1975 to gauge value’s performance compared to the broader market. It argues, “history has shown that once market sentiment starts to anticipate the end of a recession, value tends to stage a powerful and long-lasting rally.”
The data show that value cycles are “tightly linked to economic cycles,” the article reports, adding that the length of the current anti-value cycle has been “driven by the lack of a recession.” The current Covid-related recession, it argues, “has ended the longest and most shallow expansion on record in the U.S.”
The market’s favoring of growth is reflected in what the article describes as “the excessive multiple expansion that has driven the vast majority of its return since 2017” but asserts that this is not sustainable: “The last time we saw such a contrast in multiples and performance was during the dot-com era.”
The track record of the value strategy during and after recessions has been “impressive,” the article notes, adding that it “begs the obvious question, ‘if you don’t like value now, when will you?”
The article concludes, “To us, value investing is far from dead. The arithmetic of purchasing assets that are significantly discounted to the present value of their future cash flows can’t die. However, endless multiple expansion, which has never been a sustainable source of excess return, can die.”
