What Happened to Value Investing?
Many investors are understandably questioning the merits of value investing.
For 10 years, the approach – picking stocks that appear to be trading for less than their perceived intrinsic value – has failed to keep pace with investing for growth. And the gap has been widening, as illustrated in the chart below.
The Russell 1000 Value Index has averaged a five-year annualized return of only 7.5%, little more than half the 13.4% corresponding return on the Russell 1000 Growth Index. A $10,000 investment made
in 2014 in value stocks, as measured by the index, is now worth $14,330, or almost 25% less than the $18,744 cumulative return on the same $10,000 investment in the stocks of companies expected to grow more rapidly than their sector or the overall market.
Some of the discrepancy between value and growth performance can be attributed to differences in the underlying industry weightings comprising each index. The Russell 1000 Value Index has only a 5.9% weighting to information technology, compared with a 37.3% weighting in the growth index. Large-cap technology stocks, such as Amazon, Apple and Microsoft, have been among the best performing stocks since the 2009 financial crisis low.
Similarly, financial and energy stocks account for 23.4% and 9.2%, respectively, of the Russell 1000 Value Index. Many financial stocks have recovered from their financial crisis nadirs in 2009 but have struggled to appreciate due to stricter capital requirements, heightened regulatory oversight and low interest rates. Although the United States is now a major exporter of energy, the energy industry as a whole continues to struggle with profitability due to excessive supply relative to global demand. In contrast, financial stocks account for 3.2% and energy stocks just 0.4% of the Russell 1000 Growth Index.
Although the differences in industry weightings explain the disparity in investment performance between these two popular indices, it does not address the full scope of underperformance at the individual stock level. Value stocks are underperforming growth stocks for both secular, or long-term, and cyclical, or short-term, reasons.
On the secular front, many industries have been subjected to increasing disruption from technological innovation over the past decade. Technological disruption comes in many forms, including innovative products and services, alternative distribution channels, and reduced barriers to entry for new competitors. Examples of disruptive technological innovations include e-commerce, enhanced connectivity through social media and the Internet of Things, artificial intelligence and machine learning, robotics, electric and autonomous vehicles, cloud computing, blockchain technology, and the coming introduction of 5G wireless communications networks. Many industries, including retail, media, advertising, manufacturing and financial services, are transforming as a result of these disruptive forces. Technological innovations will continue to exert a powerful influence on these and other industries for the foreseeable future.
At the same time, changing consumer preferences, particularly among Millennials, has adversely affected many legacy businesses with well-established brands. As a group, Millennials demonstrate less loyalty to existing brands and a greater willingness to change consumption patterns. Frequent switching by consumers to new products and services based on near-instant and continuous feedback from social media networks is increasingly the norm.
Cyclical forces have also pressured stocks in many industries. Many companies within the traditional value sectors of manufacturing, shipping, banking and energy are facing near-term pressures as a result of weakening global economic growth, low interest rates, trade uncertainties and other geopolitical concerns. However, unlike secular forces, cyclical forces are short term and can be reversed with improved geopolitical conditions and pro-growth economic policies.
So, is this the time to sell growth companies and replace them with underperforming value stocks? Not necessarily. When assessing individual companies, focusing just on distinctions between growth and value is often misguided. As Warren Buffett noted years ago, “Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.”1 We agree.
Our investment approach at Evercore Wealth Management is informed by elements of both value and growth. We are long-term, fundamental investors, analyzing each prospective equity investment on its own terms to develop an understanding of how the business operates, how profits are generated, and whether those profits are utilized to benefit shareholders. Our goal is to determine what we think a business is worth today and what we believe it could be worth in the future. We seek out attractively valued companies benefiting from positive catalysts for change. At the same time, we avoid purchasing low-quality businesses simply because they are historically cheap. Cheap doesn’t mean they won’t get cheaper still.
Identifying high-quality companies with durable competitive advantages, sustainable economics, and innovative business models that deliver compelling value will be key in this rapidly changing investment landscape.
Aldo Palles is a Managing Director and Portfolio Manager at Evercore Wealth Management in Palm Beach. He can be contacted at aldo.palles@evercore.com.
Evercore Wealth Management, LLC ("EWM") is an investment adviser registered with the U.S. Securities and Exchange Commission under the Investment Advisers Act of 1940. EWM prepared this material for informational purposes only and should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. It is not our intention to state or imply in any manner that past results are an indication of future performance. Future results cannot be guaranteed and a loss of principal may occur. This material does not constitute financial, investment, accounting, tax or legal advice. It does not constitute an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Specific needs of a client must be reviewed and assessed before determining the proper investment objective and asset allocation which may be adjusted to market circumstances. EWM may make investment decisions for its clients that are different from or inconsistent with the analysis in this report. EWM clients may invest in categories of securities or other instruments not covered in this report. Descriptions provided in this material are not substitutes for disclosure in offering documents for particular investment products. Any specific holdings discussed do not represent all of the securities purchased, sold or recommended by EWM, and the reader should not assume that investments in the companies identified and discussed were or will be profitable. Upon request, we will furnish a list of all securities recommended to clients during the past year. Performance results for individual accounts may vary due to the timing of investments, additions/withdrawals, length of relationship, and size of positions, among other reasons. Prospective investors should perform their own investigation and evaluation of investment options, should ask EWM for additional information if needed, and should consult their own attorney and other advisors. Indices are unmanaged and do not reflect fees or transaction expenses. You cannot invest directly in an index. References to benchmarks or indices are provided for information only. The securities discussed herein were holdings during the quarter. They will not always be the highest performing securities in the portfolio, but rather will have some characteristic of significance relevant to the article (e.g., reported news or event, a new contract, acquisition/divestiture, financing/refinancing, revenue or earnings, changes to management, change in relative valuation, plant strike, product recall, court ruling). EWM obtained this information from multiple sources believed to be reliable as of the date of publication; EWM, however, makes no representations as to the accuracy or completeness of such third party information. Unless otherwise noted, any recommendations, opinions and analysis herein reflect our judgment at the date of this report and are subject to change. EWM has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any such information becomes outdated, inaccurate, or incomplete. EWM’s Privacy Policy is available upon request. EWM is compensated for the investment advisory services it provides, generally based on a percentage of assets under management. In addition to the investment management fees charged, clients may be responsible for additional expenses, such as brokerage fees, custody fees, and fees and expenses charged by third-party mutual funds, pooled investment vehicles, and third-party managers that may be recommended to clients. A complete description of EWM’s advisory fees is available in Part 2A of EWM’s Form ADV. Trust services are provided by Evercore Trust Company, N.A., a national trust bank regulated by the Office of the Comptroller of the Currency and/or Evercore Trust Company of Delaware, a limited purpose trust company regulated by the Delaware State Bank Commissioner, both affiliates of EWM. Custody services are provided by Evercore Trust Company, N.A. The use of any word or phrase contained herein that could be considered superlative is not intended to imply that EWM is the only firm capable of providing adequate advisory services. This material does not purport to be a complete description of our investment services. This document is prepared for the use of EWM clients and prospective clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of EWM. Any unauthorized use or disclosure is prohibited. The Chartered Financial Analyst and CFA trademarks are the property of CFA Institute. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™ and CFP® in the U.S.
IRS Circular 230 Disclosure:
Pursuant to IRS Regulations, we inform you that any U.S. Federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for (i) the purpose of avoiding IRS imposed penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. This information is provided for information purposes only and does not constitute financial, investment, tax or legal advice.
©2016 Evercore Wealth Management LLC. All rights reserved.
