The popular US day trader Dave Portnoy recently declared that Warren Buffett was past his prime and that a new world of investing has arrived – one presumably populated by lots of tech stocks favoured by Dave. You can read his comments here – https://www.businessinsider.com/dave-portnoy-interview-why-warren-buffett-airline-stock-sale-wrong-2020-6?r=US&IR=T
Obviously the Sage of Omaha aficionados have reacted with thinly veiled horror, accusing the day trader of his own hubris for impugning the decades long record of the boss of Berkshire Hathaway. But to be fair to Dave his possibly ‘direct’ comments do speak to a wider debate within investment. Put simply, is value investing dead? Now for balance, it’s worth saying that Buffett hasn’t really been a proper value investor for decades – he gave up looking for all those Graham Net nets yonks ago because the US markets had arbitraged them away.
But if we define value investing more broadly as buying decent businesses with cheap shares, then a great many investors would fall within that definition. And if we are honest, their track record hasn’t really been that great. Put simply value investing has stalled for decades and arguably the Covid pandemic has turned the headwind into a gale force storm. Who’d want to own many traditional value stocks as whole sub sectors go into the corporate rubbish bin?
James Anderson at Baillie Gifford has been making what I think is a decent argument for decades that traditional, value influenced investing is dead wrong about growth. He, and many others, have suggested that there are profound changes afoot in the global economy and that technology is at the forefront of a bunch of structural changes that favour scaleable, global growth stocks. I suspect that James and Scottish Mortgage were slowly winning that argument even before the pandemic emergency but over the last six to seven months their argument has carried enormous force. This blog has documented the astonishing strength of the tech sectors and especially the Faangs. But the chart below I think tells that story even better than the Faangs. It shows the share price of Nvidia, the champion graphics processor champ that is simultaneously riding the e-gaming and cloud transformations. I own shares in Nvidia and even I think this chart is insane. But boy is it getting hard to argue with the growth bulls. Clearly this time it really is, currently, a bit different!
Paul Cuatrecasas who previously founded Alegro Capital in 2003 and also co-founded ARC Associates in 1993 is behind a new research venture called Aquaa Partners Investment Research. Their latest research paper is worth a read on this subject – The Death of value investing and the dawn of a new tech driven investment paradigm.
I’ll pull out a few choice bits, and accompanying charts – which truly are extra ordinary.
Figure 1 below illustrates total shareholder returns since 1999 for key tech and non-tech indices.
“In the 22 years since 1999, the Nasdaq 100 Tech index has delivered a TSR to investors of 11,630 per cent. Tis compares to the Nasdaq 100 non-tech index TSR of only 4,543 per cent (despite this non-tech index including Amazon and Alphabet). the TSR since 1999 of the Nasdaq 100 Tech Index was almost 13 times greater than the TSR of the FTSE 100 Non-Tech index (838 per cent). Figure 1 also illustrates how these diﬀerences have become even more pronounced since 2009 as tech began to pick up exponential speed. the TSR of the Nasdaq 100 Tech Index from 2009 to 31 July, 2020 was six times greater than that of both the FTSE 100 NonTech index and the DAX Non-Tech index.”
In other words, over a 22-year period technology stocks have delivered an approximate return 15 times greater than non-technology stocks, in spite of the dot-com collapse from 2000 to 2003. Even in the last five and half years, since January 2015, the Nasdaq 100 has delivered a TSR close to 3.5 times greater than that of the average of the non-tech indices
Ah, but surely all these amazing returns have come with much greater risk? Not so, says Aquaa. They point to the chart below. Their chosen measure of risk is based on calculating the maximum point of loss in each year since 1995 from the first day in the year of trading. Yearly averages are calculated, and the figures amalgamated. The exercise is then applied to both tech and non-tech stocks. Again, the Nasdaq 100 index is used as the source of tech sector data, while the non-tech sector is measured by the average of non-tech data for the FTSE 100, CAC 40 and DAX 30 indices
According to the Aquaa report ”in the 12 years from 2009 to 2020 (seven months to 31 July, 2020), the average of the maximum point of loss for the tech sector was only 7.6 per cent, compared to 12.7 per cent for the non-tech sector”.
So, what’s the driver of this extra ordinary transformation – which the report reckons could continue for many years hence? “ It’s the eﬀect of Moore’s Law materialising in all industries as the world becoming more technology dependent. Tis force is only to going to grow, despite the inevitable market cycles.”
And what happens if the regulators come after the tech giants ? “….if the concern is that larger tech companies are at risk of being broken up by regulators, then what gets spun out, split oﬀ or severely taxed can, and likely will, still grow…Our view is that when Big Tech falls, smaller tech develops to take its place. The tech industry is characterised by a faster rate of change than traditional industries. This fast rate of change lends itself to greater adaptability and growth”.
As for concentration risk, there’s always the next generation of businesses in new sectors coming along to challenge this years Faangs. Cue the emergence of AI, robots, drones, electric self-driving vehicles, 5G, VR, AR, holograms, renewable energy, plant-based meat, vertical farms, 3D printing, blockchain. “All this advanced tech is emerging now and is growing exponentially fast”.
These concurrent transformations are, in part, being helped along by a wall of money flooding into venture capital. In 2019, approximately $161 billion of venture capital was invested in 22,645 companies in North America and Europe, yielding an average of $7.1 million invested per company,. By contrast, in the dot-com boom years of 1998, only $6 billion of venture capital was invested in only 979 companies, the majority of them in North America.
Add this all up and you see that growth investing is “unconstrained it is not a bubble. On a long-term basis, growth investing in tech delivers a superior balance of risk-reward, i.e. “value”, compared to the traditional value stocks. Tech stocks are the new value stocks. “
Their advice to fund managers is nicely summed up below:
- “ Invest the same amount every month, because no one can time the market consistently.
- Invest in a basket of tech companies, the best ones you or your advisers can find, or the best tech indices, and then don’t touch them.
- When a market crash has clearly arrived because the markets are consistently showing lower lows and lower highs over a period of several months and a state of maximum pessimism is being reached, then you plan a special one-off “bottom” purchase. Allocate your one-off purchase to the highest quality tech companies and also consider buying out-of-the-money long-term options. As Warren Buffett said, “price is what you pay, value is what you get.”
- Apply geographical diversification to your tech stocks. The next 20 years in tech are going to be as much if not more about Asia and China than about North America, so be sure to have a mix of tech stocks from North America, Europe and Asia.”
I have a great amount of sympathy for this argument and in truth implement large parts of it in my own portfolios. But despite this confirmation I can’t quite bring myself to confirm the whole thesis. A few salient objections.
The first is that I’ve never seen value and growth as opponents. I’m perfectly happy to run a large portion of growth alongside a smaller portion of value. That’s especially true for different geographies – value has real virtues in Europe and the EM exc China markets. Less so in the US.
Next up I’m a little uncertain where to draw the line between tech and non tech. In my experience a great many ‘legacy’ non tech businesses and actively building huge tech businesses. Walmart is a huge tech business. The Frasers Group (Sportsdirect) ahs an enormously successful online business. Is Easyjet or Ryanair a legacy value stock or are they pioneers of internet enabled travel ? Put simply, many legacy businesses are now digitising their operations and products like crazy – and making huge amounts of money.
Next up, as I have mentioned on this blog before, my concern – and hope – is that the US and China are about to enter a technology fuelled face off. China might react by stopping inward foreign investment in its tech businesses to safeguard its national interest. That could throw a spanner in the whole argument for tech.
Lastly, I have m deep suspicions around tech profitability and margins, best explained by a small example. I have a few cloud based services which seem to become ever more expensive. Like many consumers with endless online subscriptions I have noticed that tech inflation- sure you get more product but you pay more for the experience – has become a real challenge. That’s wonderful for the margins of the tech businesses but as they become large parts of consumer expenditure, and tech service inflation becomes more noticeable, I’d expect to see real pushback on those massively profitably margins.
Overall though I buy large parts of the pro growthy argument above but I slightly dispute the idea that tech is less risky. Sure, the timescales used in the Aquaa report validate their drawdown conclusion but plenty of much longer-term studies have shown that overall growth stocks – tech stocks – are indeed much riskier.
But maybe value is less risky afterall…..
Some evidence for this comes from the always excellent Nicholas Rabener of Factor Research in another paper out this week. You can see this one here – https://www.factorresearch.com/research-how-risky-are-value-stocks?mc_cid=3f67bc3d4b&mc_eid=d8376c4e49
He asks just how risky are value stocks versus growth stocks? The answer, counter intuitively given traditional conceptions of risk premia, is that value is actually less risky. Academics react with puzzlement to this – “excess returns from Value are frequently explained by the factor representing a risk premium. If Value stocks are less risky, how can it be a risk premium strategy?”
What’s sort of well understood is why value might outperform – “on the behavioral side, there is an extrapolation in expectations. Since cheap companies have been performing poorly, this pattern is expected (incorrectly) to continue….on the other hand, the rational markets advocates argue that cheap stocks are risker companies. Given this, it is somewhat counterintuitive for financial analysts to consider cheaper stocks safer than expensive ones.”
By crunching data on two portfolio baskets of stocks, one value, one growth, Rabener finds that cheap stocks were less volatile on average than expensive ones over the period from 1951 to 2020. He also calculates that the maximum drawdowns over the approximately last 70 years, which highlights that cheap stocks experienced lower drawdowns than expensive stocks on average.
In part this counterintuitive result is likely “explained by looking at the extreme ends of the US stock market. In one corner, we have the cheapest stocks that are trading at very low valuations…In the other corner, we have the most exciting and glitzy businesses of the US economy, which are trading at nose-bleeding high valuations.”
Yet we also know that “at the average market level, cheap stocks were riskier than the entire stock market given higher volatility and larger maximum drawdowns during crisis times. Secondly, there were times before when cheap stocks significantly underperformed the stock market, e.g. during the tech bubble in 1999. An investor focused on Value investing is, therefore, hoping to be compensated for holding more risky stocks. There is a quasi-religious notion among Value investors that maintaining exposure will be rewarded with positive returns eventually”.
Rabener concludes that value investors “get compensated for holding extremely unpleasant stocks, which causes investors to have incorrect expectations and essentially represents a liquidity-providing strategy. In contrast, holding the most expensive stocks is usually exhilarating as these represent innovative businesses that are growing rapidly, and an activity for which investors are willing to pay a premium to participate”.
My own bottom line is to repeat what I said earlier. Value still has its uses and can sit alongside growth, especially in certain markets. I’m also of the view that legacy businesses successfully embracing digitisation can reap huge rewards. But to say that value investing is dead is a much bigger ask – one that i think over the long term hasn’t been proven…yet.