Value is dead — long live value
They reap rewards buying into underpriced companies, waiting for the market to crash
VALUE investing, the conventional folklore has it, can be traced back to two academics, Ben Graham and David Dodd, who taught Columbia Business School students that the way to come out ahead in the stock market is to buy companies that are priced below their intrinsic value according to fundamental analysis.
In short, it means buying cheap shares, but is that a useful distinction to make these days?
The boundaries have become blurred over the years.
Those who regard themselves as true value investors wear the badge with pride and, though they may suffer in the comparison, sound a lot like bearded prophets on street corners holding cardboard placards warning of impending doom.
Piet Viljoen, chairman and founder of RE:CM, admits there are few genuine value investors left in South Africa, but says it comes down to how you define a value investor. Instead, many people are following a ‘‘growth investment” route, picking shares that appear set to deliver uninterrupted returns, irrespective of whether the stocks appear expensive.
“Genuine value means the share is priced well below the company’s intrinsic value and there’s no one method that’s correct, although I believe one way is consistently more successful,” he says.
‘‘We don’t do forecasts and pin our hopes on an outcome. We make long-term assumptions on margins, market share, industry dynamics and the regulatory environment. We look at cash flow over time, discounted back to present value and compared to the current price.”
It is here that Warren Buffett’s maxim — that price is what you pay, value is what you get — can be best applied.
Viljoen ascribes the trend away from value investing to the human tendency towards herd behaviour. “Five years ago the positions were reversed. To be a value investor means being contrarian, buying stuff nobody else wants.
‘‘Fashions change through the cycle and people will call themselves value investors from time to time. Right now, few could earn that label. They’re sitting on expensive stocks with PE ratios of 15.”
According to Viljoen, being a true value investor doesn’t mean making cavalier buying decisions.
“You need a wide margin of safety to lower your risk, even if it means a temporary loss of capital as the price continues to fall. We get less of the upside, where we withdraw, but we experience far less of the downside and the compounding effect is powerful. Over the full cycle from peak to peak, that’s where you’ll see the success.
“The quantum of the outperformance when markets decline more than makes up for longer periods of underperformance.” Mistakes? He’s made a few. “We hold on until we realise the analysis was flawed and we see the real value, or we sell if the work is correct and the price has increased to the fair value we calculated. You have taken account of the growth in your calculation of fair value, so if you don’t sell then, you won’t know when to sell.
“You must know when to sell before you buy. We make mistakes — there are so many variables, but good investors can see that early on. Having an expensive share and not knowing it is a mistake,” he says.
Cannon Asset Managers chief investment officer Adrian Saville, who would also be classified as a ‘‘value investor”, agreed that from mid-2008 the value approach has largely been abandoned.
“There was widespread migration, but that was to be expected. Most managers don’t
We get less of the upside, where we withdraw, but we experience far less of the downside ... Over the full cycle from peak to peak, that’s where you'll see the success. — Piet Viljoen, RE:CM
stick with an approach that’s shut down.
‘‘Research from Avior shows the current environment is the most growth-dominant it’s been in a decade. But no single style has a permanent monopoly on alpha. On balance, value tends to work more, but investors are obsessed with earnings and the perception that they will continue uninterrupted.”
Saville said that since 2008, large companies had outperformed smaller firms on the JSE, while valuation extremes intensified. Companies whose share prices were growing kept up this momentum, which caused many people to rethink the contrarian approach.
“This cannot be sustainable. Value will reassert itself. We don’t know when the moment will come, but when it comes we’ll get the alpha [which means they will outperform the rest of the market] because the market shift will be dramatic and unexpected.
“Value investors make lots of
Value will reassert itself. We don’t know when the moment will come, but when it (does) ... the market shift will be dramatic and unexpected. — Adrian Saville, Cannon Asset Managers
alpha in a short space of time.”
Saville says growth investors often fool themselves about how long it will last.
“There are always reasons given for uninterrupted growth and how things will be different this time, but the reality is that the numbers are hard to reconcile. Take SAB, which is sitting on a huge valuation. They might deliver fantastic earnings growth, but to justify the numbers would be to believe this time is different, and that means defying history. It will all come to an abrupt, dramatic end.”
However, unlike some value investors, Saville is prepared to let companies’ share prices climb above what he considers ‘‘fair value”.
“When you get recognition of value there’s no sweeter space to be in than having price momentum. We allow the price to run to two standard deviations above fair value to capture that [outperformance] — don’t jump off too soon and go when the momentum dies.”
It’s not value investing any more, it’s recovery investing. These are badly managed companies, not value. They need a good mechanic. — David Shapiro, Sasfin Securities
But it’s never easy to decide when to sell, and Saville agreed that getting caught in a sudden, dramatic change of sentiment is a danger.
“There is a risk of being seduced, and no style is immune to mistakes. Any approach must constantly re-examine assumptions for weakness, otherwise you’re being negligent. Sometimes companies have assets that are poorly managed, redundant or the wrong assets, or they can lose their industry.”
However, those who favour the growth approach feel value investors are often imprisoned by their own ideology.
David Shapiro, Sasfin Securities deputy chairman, says the problem with value investing is that everyone is privy to the same information in the internet age.
“We can sift through it using whatever filters we want to apply, so it’s not really possible to find discounted shares. It’s not value investing any more, it’s recovery investing.
‘‘These are badly managed companies, not value — they need good management. They deserve to be trading at that level and it comes down to how the assets are used.”
Shapiro says he doesn’t want to gamble with anyone’s money.
We [hold] if we have confidence in the underlying valuation ... You can’t be stubborn and shouldn’t compound a mistake if the margins of safety disappear. — Karl Leinberger, Coronation Fund Managers
“Do you want to hang around to see if the value investor is right? Would you buy Harmony right now on promises of a turnaround?
“I can rely on a guy like Brian Joffe, even if Bidvest’s PE is sitting at 15 or 16. I can trust a Kevin Hedderwick (CEO of Famous Brands), a Stephen Saad, and Adrian Gore (CEO of Discovery), a Whitey Basson (CEO of Shoprite) to run a good company,” he says.
“Richemont, Naspers, companies like that, will continue to pump out the results. I feel safe there, not in an AngloPlat or Anglo American where there are lots of issues and a history of mismanagement.
‘‘That’s not value — those companies need a good mechanic,” Shapiro said.