Between the 1970s and 2007, value investing—where investors identify stocks that are trading below their intrinsic value—reigned supreme for two generations of investors. But for the last 16 years, growth investing—where stocks are identified by their future potential for growth and returns—dominated, and an article in the Chattanooga Times Free Press asks whether value investing’s long stretch of success was an anomaly, or if investors need to rethink how to reapply the strategy.
Value investing’s roots trace back to the years after the Great Depression and the work of Columbia University’s Benjamin Graham and David Dodd—though the term wasn’t used back then. The two men produced the first systemic effort to determine the real or intrinsic price of a stock; using basic factors like earnings, dividend payouts, and assets held by the company, this method gave investors a way to select stocks that were trading at below their intrinsic value and therefore had a greater potential for profits down the line. Value investing was made even more attractive by the most famous value investor of all time: Warren Buffett, who deployed the strategy to enormous success. Many investors hopped on his bandwagon and received outstanding returns for decades, until the financial crisis in 2007, the article relates.
Since 2007, however, value investing has failed to produce those kinds of returns, even though the strategy remains intellectually sound. Meanwhile, growth has crushed value; since 2007, the S&P 500-tracking ETF has trounced its value counterpart by more than 200 percentage points. But also since 2007, there’s been a shift towards secularism in the macro economy, and monetary policy was greatly loosened as the Fed worked to stimulate the economy in the aftermath of the crisis. Growth stocks benefitted from lower interest rates, as investors were more likely to take risks and wait longer for their returns. On the flip side, value stocks do better when interest rates and inflation are higher. This proved true last year, when value once again dominated growth stocks after the Fed raised interest rates. But as inflation continues to cool, and investors dove into the AI frenzy, growth stocks have retaken their crown.
In addition, as the economy becomes increasingly more digital and reliant on technology such as AI, it can be harder to identify valuations. Graham & Dodd used tangible assets such as mines, factories, and transportation to determine valuations; while many companies are still valued by those things, more and more companies are being valued by intellectual property—for example, Apple. Intangible assets such as patents, technology, and creativity aren’t taken into account by standard metrics such as price to book, which divides share prices by a company’s tangible assets on a per share basis. Indeed, 83% of S&P 500 companies were comprised of tangible assets in 1975; now, tangible assets make up only 10% of S&P 500 companies while 90% are intangible, the article details.
Spending on research and development at companies like Apple isn’t capitalized; they’re expensed like payroll, reducing current profits while increasing the potential for future profits. That distorts other standard valuation metrics such as price to earnings, making those sorts of value indicators increasingly irrelevant. But value investing shouldn’t be considered invalidated; buying low and selling high is still the key to successful investing. Rather, value could use a bit of a redefinition, and the old metrics and standards should be upgraded in order to evolve with the new digital economy, the article concludes.
