Is value investing dead?

In August 1979, BusinessWeek boldly claimed “The Death of Equities” in the United States.

The article encapsulated investor's frustration that equities had failed to live up to their reputation as an inflation hedge. Over the preceding decade, nominal equity returns had amounted to just 3.1% per year but after taking into account soaring inflation, their real returns were much worse.

As a result, investors were fleeing equities in droves. 7 million shareholders had defected from the stock market since 1970 and mutual funds had reduced their exposure to stocks from 80% to just 50%. Conditions were so bad that few corporations could 'find buyers for their stocks'.

BusinessWeek saw no end in sight, claiming: 'For better or worse, then, the US economy probably has to regard the death of equities as a near-permanent condition – reversible someday, but not soon'.

Resurrection

What followed was one of the best periods of stock market performance in history.

Shortly after BusinessWeek's publication, equities went on a two-decade tear, producing compound annual returns just shy of 20%. Businessweek had encouraged its readers to pull out precisely when they should have been piling in.

And despite warning readers away from equities, the article alluded to their attractiveness many times: for example: 'the average stock price is now about 60% of the replacement value of the underlying assets'. Or 'companies have jumped on low stock prices to set off the biggest takeover binge in history'. And finally: 'other corporations are following a slightly different strategy: Buying up their own shares'.

Clouding that realisation, though, was the belief that America had 'entered a new financial age' where 'the old rules no longer apply'. BusinessesWeek went so far as to say: 'low stock prices remain a disincentive to buy'.

BusinessWeek's mistake was that it extrapolated the difficulties of the past, instead of realising that they sowed the seeds for a much brighter future.

History rhyming

Fast forward to 2017 and it seems that history is rhyming.

This time it's the Australia Financial Review warning Warren Buffett, and all value investors, that ”value investing is dead.”

According to the AFR 'there is so much change going on in the world that value investing, as a strategy, is on its way out.' Sound familiar?

The AFR goes on to compile a long list of examples of when value investing hasn't 'worked'. First was during the tech boom of the late nineties and then during the resources boom of the noughties. Now, the AFR claims that the rise of passive and quant strategies have claimed value investing's scalp.

It's a bold claim to say what has worked for the best part of a century will no longer do so. Investors have a tendency to give up on conventional wisdom precisely when it's needed most. Extrapolating short term performance rarely ends well.

Instead of predicting its demise, could it be that the AFR just had their very own BusinessWeek moment?

Only time will tell but before I sign off, I'd like to clear up a few inconsistencies.

Value metrics have very little to do with value

The AFR claimed that 'buying stocks with the lowest valuations is just not working.' By 'valuations', they are presumably referring to traditional value metrics like price to earnings (P/E) and price to book (P/B).

Value investing is not about buying stocks on low P/Es and P/Bs. Those metrics have very little to do with value.

A business's value is based on how much cash it can produce, how soon, and how sure we are of this happening. Comparing the share price to earnings doesn't adequately capture this.

Price is more important than growth

The AFR also claims 'just like it wasn't a good idea to go long on a company making carriages for horse transport in 1910, it might not be a good idea to buy these blue chips'. 

In other words, the AFR is implying that growth is a prerequisite for a good investment, but this fails to acknowledge the importance of entry price.

A slow growth or even declining cash flow stream can be a fantastic investment if the entry price is low enough. That many investors avoid such businesses can even accentuate their attractiveness.

Traditional media is often a contrary indicator

Finally, seasoned investors know that you shouldn't take traditional media very seriously. A newspaper's primary incentive is to sell more newspapers, not to provide accurate predictions.

This means journalists often sensationalise things and rarely back their predictions with real money. 

So the media is best thought of as an accentuated representation of consensus opinion. History has shown that it can be a fantastic contrarian indicator.