IT’S GROWTH’S SHINING MOMENT NOW, BUT VALUE WILL HAVE ITS DAY IN THE SUN

Less-popular stocks have benefits, with time and patience, Tom Bradley writes.

I see a lot of investment managers. Between my roles at the Vancouver Foundation and Steadyhand, I sit in on 70 to 75 presentations each year.

When you do that many, you start to identify some patterns. For instance, everyone buys high quality companies. Nobody pays too much. The size of the fund or firm is never an issue. And Warren Buffett is quoted repeatedly.

At this point in the investment cycle, however, there’s another trend that has emerged. Equity managers who pursue a value style have poor returns, while more growth-oriented managers are flying high.

Both categories cover a wide array of approaches, but generally speaking, value managers focus on stocks that trade at low valuations. The price-to-earnings, price-to-cash-flow and price-tobook-value ratios are below those of the overall market. The companies in their portfolios aren’t growing fast, and in many cases, are going through a rough patch.

Growth managers’ presentations are peppered with words like “world leaders,” “sustainable competitive advantage” and “predictable earnings.” Their companies are doing better and it’s reflected in the valuations. These managers are willing to pay more for rising profits. And in general, they hold fewer cyclical and resource stocks.

Over the long term, buying value and ignoring the shiny, well-liked stocks has paid off. Value has beaten growth. But since the financial crisis, the opposite has been true, with a number of factors contributing to the reversal.

First of all, investors were looking for an alternative to lowyielding bonds. One sector that’s benefitted was the consumer staple stocks (food, beverages, tobacco, and household products).

Companies like Unilever, Nestle and Diageo have modest revenue growth, but their predictability and growing dividends helped push their stock prices higher. Their P/E’s are now well over 20 times, which is three to five points higher than historical averages.

It’s also been a wonderful time to own technology.

The FAANG stocks (Facebook, Amazon, Apple, Netflix and Alphabet’s Google) have carried the U.S. market.

Meanwhile, the perceived cheap parts of the market where value managers lurk, including energy and resources, have yet to come to life.

I’ve met value managers who have unearthed interesting themes and made astute stock picks, but without the staples and FAANGs, they’ve not been able keep up.

So, it’s time to ask, is value investing still valid? In a world of rapid technological change, are iconic investment managers like Seth Klarman and Jeremy Grantham, and firms like Brandes and Longleaf Partners still relevant? To answer these questions, we need to look back at why value investing has worked so well over the long term.

At the core of all value managers’ philosophy is the concept of reversion to the mean. The rocket ships will eventually come back to Earth and the laggards will improve, or at least get less bad.

Value stocks don’t grow as fast or reliably, but the price is much lower. Managers aren’t paying a premium for growth in sectors like pharmaceuticals, energy and European financials.

With a lower price comes lower expectations. Value stocks have already disappointed, so shareholders are ready for bad news, maybe even expecting it. These companies don’t have to do much to surprise the market.

And buying less-popular stocks has another advantage. The cost of trading can be less. For every trade, there’s a buyer and seller, but with troubled companies, the urgency is on the sell side. Investors aren’t lining up to buy value stocks.

Only once has the valuation and performance gap between value and growth been wider. It was during the tech boom in the late ’90s, when value managers were being referred to as “dinosaurs.” What happened? Well, when the boom bust, they smoked the growth managers for the next seven years.

It’s easy to be blown away by what growth managers have done. Certainly, I’ve been impressed by their foresight to hold the FAANGS and consumer stocks. But we shouldn’t forget about the lowly value managers. They don’t look as smart right now, but there are good reasons to believe they’ll have their day in the sun.

Indeed, it may be a long, hot stretch if it mirrors the market’s current love affair with growth and predictability.

DAMIEN MEYER/AFP/GETTY IMAGES Technology stocks may be the driving force of the U.S. market now, but don’t count out the long-term potential of value investing, says Tom Bradley. The value managers’ core philosophy, Bradley says, is the idea that the laggards will improve, or get less bad.