At-a-Glance: Key Takeaways on Value Investing & Market Dynamics
- Value Investing Endures – Despite decline, historical cycles suggest a strong comeback.
- Short-Term Hype Dominates – Deep value stocks like BMW are overlooked in favor of quick gains.
- Shareholder Returns Drive Growth – Buybacks & dividends boost return potential amid low reinvestment.
- Market Inefficiencies Create Opportunity – Undervalued sectors offer hidden potential.
- History Signals a Rebound – Past cycles show value investing thrives after downturns.
Once a part of the structural foundation of equity markets, the community of value-oriented boutiques has been significantly impacted by these distortive phenomena. It is indeed a business strategy offering little insulation from these challenges. A number of firms have closed, while some others have adjusted their strategies to be more in keeping with the present investing zeitgeist. It also seems that very few of the remaining value-focused firms have been of a mind to grow staff and train the next generation of young enterprising value investors. Having observed this value community attrition for a period of years, you can imagine my surprise when, in the midst of considering whether I was personally a relic of a bygone era, I came across the following passage from a well-known global auto analyst at one of the world’s largest investment banks:
“Whilst BMW’s new cash accounting highlights almost EUR 70 per share in industrial net cash and, hence, a very deep value investment, the lack of a short-term “dream” narrative and a lack of value investors leaves BMW often overlooked.”
We only use a small amount of hyperbole in saying that this analyst has captured the current state of equity investing in a single sentence. Rephrasing his words; “Obvious substantial undervaluation doesn’t matter because there are no value investors left to care and all the non-value investors care about is a “short-term dream narrative.” Factual fundamental information concerning business value is not a focus, nor is its relationship to security prices.” Maybe he is correct that we price-conscious, value-oriented investors are among the last of the Mohicans. Maybe the fundamental value investing community no longer oversees an asset base that is powerful enough to facilitate price discovery and reconcile undervaluation. Or, perhaps more accurately, the fundamental value investing community is currently unable to participate in the price discovery process in a manner broadly consistent with its fundamental views. So maybe a tree doesn’t make a sound if it falls in the woods and there is nobody to hear it? Maybe it doesn’t matter if an obvious “very deep value investment” exists but there are no value investors left to care? You almost can’t blame folks for wondering if value investing is dead.
Well, while others may not care, we continue to care quite a bit. And furthermore, notwithstanding its lack of “dream narrative” and “lack of value investors,” over the five years through September 30th, 2024, BMW has produced a total shareholder return, in U.S. dollar terms, of 10.9% per year, which stacks up well relative to equity market returns over long periods of time. Furthermore, it is most certainly worth noting that BMW’s shareholder return occurred in spite of the company seeing its price-to-sales multiple decline by roughly a quarter and its price-to-earnings multiple cut in half over that period. Despite analyst apathy, a substantial derating, and “a lack of value investors”, pretty good outcomes do still seem to follow when a valuable business is purchased very cheaply. Somebody pretty clever once called that a margin of safety.
“The idea of a margin of safety, a Graham precept, will never be obsolete. The idea of making the market your servant will never be obsolete. The idea of being objective and dispassionate will never be obsolete. So Graham had a lot of wonderful ideas.”
Charlie Munger
There are important practical implications of these developments and some of them actually seem quite favorable for fundamental investors. It has been said that “successful investing is about having people agree with you… later.” Yet, other investors coming around to your point of view at some point in the future, deciding to purchase the stock, and becoming the source of upward revaluation of the company, is only one possible driver of a successful equity investment. Other sources of return sometimes stem from companies themselves responding to unusual valuations, rather than waiting for public equity market participants to come around.
Cheap stock prices often send powerful signals to managements and boards that capital reinvestment into a business is not desired and is unlikely to be rewarded by equity market participants. The decision to reinvest capital into a business, even at attractive returns on capital, may be value-destructive if opportunities to repurchase shares at even more attractive rates of return exist.
For example, in recent years the global oil and gas production industry has radically increased shareholder returns and debt paydowns, to the detriment of reinvestment in production. It is estimated by the International Energy Agency (“IEA”) that upstream capital expenditure, as a percentage of earnings, for the entire global oil and gas industry fell from 82% in 2017 to 47% in 2022. Investment bank Barclays estimates that, across its entire coverage of European large-cap energy companies, the median shareholder distribution yield from dividends and buybacks will total 12% in 2024. Even higher shareholder returns are common among smaller-cap companies. Furthermore, capital returns to shareholders, in the form of dividends and buybacks, have also increased very substantially for many European banks and global auto companies, where valuation multiples remain quite compressed.
For a cheap, out for favor business, the recognition that business reinvestment may need to be relegated behind share buybacks and dividend distributions, when share prices are exceptionally cheap, can help to drive shareholders’ realized returns closer to the actual economic earnings of the underlying business. In other words, if you bought shares of a company trading at 5x to 6x earnings and the company distributed the bulk of its earnings to shareholders, which is an apt description of a number of current Fund holdings, you may be able to earn superior equity returns even without a multiple rerating, though a rerating may follow at some point too.
In academic terms, we are essentially suggesting that the price discovery process may have been working less well in recent years, which, to some, is a heretical claim akin to saying that inefficiencies exist. Many academics would argue that, if inefficiencies exist, investors should be able to exploit them for market-beating returns.
An investor for whom I have great respect once said, “In investing, most things will prove cyclical.” Investing is, in our decades of experience, full of tradeoffs and dichotomies. For example, the more challenging an investment environment is from a performance perspective, the better it tends to be for identifying attractive new investment opportunities. The less popular and less competitive an area of investment tends to be, the higher the probability that inefficiencies and opportunities for outsized returns exist. In many ways, our most common areas of opportunity - cheap stocks, non-U.S. stocks, and small-cap companies - seem to have become those unpopular, unglamorous, less-trafficked backwaters of equity investing. And finally, the upside and downside of a cycle tend to be proportionate to one another. In industry and investing, outsized upcycles tend to produce outsized downcycles, and large, protracted downcycles tend to produce large, protracted upcycles.
This cyclical phenomenon was certainly the experience during the late 1990s, the last time value investing was declared “dead,” and valuation spreads were at multi-decade highs. Analogously, value strategies had seen rampant outflows in the late 1990s, value firms shrunk, and portfolio managers jobs were threatened or lost. Several of the investors now considered among the legends of value investing were managers who just narrowly hung onto their jobs or firms during the late 1990s. Similarly, in recent years, many boutique firms have closed, and some have changed their stripes. A number of value investing luminaries have retired or passed away. As others in our industry have noted, we also don’t see that fresh generation of enterprising value investors being trained today. As the dot-com bubble burst, a powerful performance tailwind led to one of the strongest periods of value strategy outperformance in many decades and rapid valuation spread compression. Let’s not lose sight of the historical experience that the possum has been ferocious when awakened.
IMPORTANT INFORMATION
This publication does not constitute an offer or solicitation of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this publication has been obtained from sources we believe to be reliable, but cannot be guaranteed.
The information in this article represents the opinions of the portfolio manager(s) and is not intended to be a forecast of future events, a guarantee of future results or investment advice. Views expressed are those of the portfolio manager(s) and may differ from those of other portfolio managers or of the firm as a whole. Certain information contained in this letter constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe,” or the negatives thereof (such as “may not,” “should not,” “are not expected to,” etc.) or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of any fund investment may differ materially from those reflected or contemplated in any such forward- looking statement.
Date of first use of portfolio manager commentary: October 15, 2024
1 The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.
2 The S&P 500 Index, or the Standard & Poor's 500 Index, is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market capitalization because there are other criteria to be included in the index.
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