The outlook for value in your portfolio
Kyle Tetting: I want to bring everybody back a couple of slides here. It’s really going to illustrate a point. When you look at value stocks and growth stocks the last couple of years, look at the year-to-date; look at the one-year; look at the three-year; look at the five-year on this chart, growth stocks have really, really outperformed value. I think that there are two questions that really come up from that. One, OK, why is that? Good to know, but maybe that doesn’t inform the second question. OK, as investors, what do we do about that? What does that mean for our portfolio in the future?
Good news maybe on the first question. We anticipated a lot of this.
Click here to view the presentation by Bob Landaas at the 2019 Investment Outlook Seminar. The seminar also featured Kyle Tetting, Paige Radke and Dave Sandstrom. Each has a separate Money Talk Video. Click here for the 2019 seminar playlist on YouTube.
We know that later on in market cycles, growth stocks tend to lead. We know that then, as the cycle matures, as the economy starts to slow, you want to lean into value stocks. But you know, I think it’s important to know here that there are some reasons, there are some things that we can do.
So, just to bring you to back up to date here on where we should be, if you think about that growth versus value debate, growth’s been the winning style, no doubt. And really, that recent strong performance has shifted the long-term returns, not just the last five years. But again, you look at that 30-year number, this is the first time since I’ve looked at that chart that I’ve been able to say that growth stocks over the last 30 years have outperformed value. That maybe doesn’t sound like all that big a deal, but when you consider that we’re talking about 30-year time periods that capture multiple market cycles, almost always, value stocks are going to be the thing that leads.
Now, Bob made a very important point here, and that is that with those value stocks, you’re taking significantly less risk. So, similar returns; value stocks still look pretty good. But important to note that growth stocks, even over the last 30 years, have outperformed. Why is that?
If you look over the last three years, five years, really it’s been the FAANG stocks Facebook, Alphabet, Amazon, Apple, Netflix and Google. So what is it about those FAANG stocks that have allowed growth stocks to outperform?
Well, think back to the conversation about productivity. Initially, it was the technology revolution that drove the productivity growth of the late ’80s into the early ’90s, into the technology bust that ultimately maybe cost a lot of people who over-invested in growth a good portion of their portfolio. But again, it was that technological revolution that was kind of key to growth’s initial success.
Today, it’s data-driven. You look at the item that you purchase on Amazon that creates a number of pieces of information about you as a consumer. That data gets passed along via the iPhone that you purchased it on from Apple to Google Analytics, where Google then goes ahead and packages that as an ad on Facebook that you see when you log on. All of that data now becoming more valuable often than the actual product that it was that you bought in the first place.
It’s why a company like Tesla, for example, when you compare it to Ford, the market views those as very similar in terms of market cap, even though Ford produces 2.5 million cars a year here in the U.S. Tesla, in their existence, has only sold about 750,000. How is it that a startup company that’s been around for five years can be valued the same way that a company that far outproduces them is valued? It’s because Tesla’s generated data on every mile ever driven on their cars. That’s not something Ford can say when the first Model T rolled off the line, that they were generating data on how their users were actually using that product.
And so, when you think about what’s driven FAANG’s success, these data-driven stocks, it’s been this influx of data that’s available to us now, that data packaged in a thousand different ways and sold off.
There’s hope, though. There’s hope for value. A couple of reasons why. If you go back to 1984, you look at the annual performance of value and growth stocks. OK, growth’s really won out the last couple of years, but since 1984, pretty evenly split which one won from year to year.
So, if all you’re doing is throwing a dart at the dart board from year to year, it doesn’t really matter. Add in the fact that trees don’t grow to the sky. Consider the high growth that has happened for these technology stocks the last couple of years. It’s going to be difficult for them to continue to grow at that pace.
I think the last point maybe the most important one. That is that it isn’t just about value or growth. You know, we talk about diversification. We talk about building this balanced portfolio. Important to remember that even within business now, there are a number of maybe not traditional growth stocks. None of these FAANG businesses that are increasingly relying on this kind of data, increasingly relying on technological innovation to drive productivity growth, to drive profitability, to drive earnings.
Maybe just to put a little bit of a finer points on this FAANG stock issue that’s really driven growth for the last couple of years, you look at FAANG stocks since January 1, 2017, so really not all that long, maybe a little more than two and a half years now. The average return on a FAANG stock: About 88%. You look at the Russell 1000 Value index, up just 18.6% compared to that average FAANG stock. And importantly, none of those stocks exist in the Russell 1000 Value, something we’re going to come back to in a minute.
The other piece, though, is if you look at the Russell 1000 Growth index, 21% of that index is in those FAANG stocks. Why did that Russell 1000 Growth index do so well? Well, because 21% of your investment was up 88% on average. So, you look at maybe that outperformance, three times better returns in the Russell 1000 Growth than the Russell 1000 Value. I’d say growth was the place to be the last couple years.
Of course, the problem with value stocks the last couple of years has been the way that we measure value. When you look at that Russell 1000 Value index, it’s rules-driven. There’s nobody that looks at these stocks that build the index and says, “Well, I think that we should put this in this portfolio because that’s going to be the right investment for value investors.” No, what they do is they say, “Is this stock cheap relative to its book value?” Book value is simply what are the company’s assets minus the company’s liabilities?
So if that stock is cheap relative to its book value, that gets labeled a value stock. It gets put in that value index. Sure, there are other measures of value. Other indexes look at P/E ratios. We look at sales-to-price ratio. Bob mentioned dividend yield, which I think is a really important measure for value stocks. Most of the traditional value names are out there paying significant dividends.
The challenge with all of those measures: None of them get to what that company’s worth. You don’t get an idea of is the central idea of this business going to be able to drive earnings for the long-term? Is the central idea of this business—does it have value?
The traditional value indexes don’t get to that. A couple of years ago I stood up here. A few other speakers were up here. Each one of them brought a quote from Warren Buffett. I wasn’t prepared for that, and so I didn’t bring a Warren Buffett quote. So tonight, I brought a Warren Buffett quote for you—maybe a couple of years late. You know, I think the important thing about value here is what Warren Buffet mentions: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
And I think that gets to the heart of the issue that we’ve had with value stocks for so many years, when you consider that debate. When you consider whether it’s right to buy value or growth, forgetting the fact that it doesn’t have to be one or the other, the traditional measures of value, they’re getting you fair companies. And they’re getting them at a wonderful price, but what you miss is so many of those wonderful companies.
So, I think that the important point here is let’s keep value in perspective. Let’s figure out the role that it has in our portfolios. For years I know that many of your portfolios had heavier allocations to growth stocks than they’ve ever had in the past. I’m here to say, I think Bob mentioned it, you’re going to see value stocks become an increasingly important part of what we do over the next couple years. Why is that?
Well, first of all, value doesn’t have to mean slow growth. If you look beyond those traditional measures of value—and even within the traditional measures of value—we’re starting to see businesses now that have opportunities for growth. Within the value index ,there’s a number of really attractive health-care names, some technology companies and especially some consumer companies that look really attractive from a growth perspective, especially when you consider the strength of the consumer right now.
Add in the role that dividends can play, especially in a volatile market.
The price of your stocks, they can bounce around like crazy. But the dividend payers tend to be pretty consistent in those dividends they’re paying. And so, if you’re buying those dividend-paying stocks, you’re going to have a little bit more consistent return. You’re going to have a little bit more consistent experience with your investments.
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Dividend-paying stocks in your portfolio, a Money Talk Video with Steve Giles
The case for active funds amid volatility, a Money Talk Video with Kyle Tetting
Selections important to your investments, a Money Talk Video with Kyle Tetting
And then I think especially with those value indexes, those traditional measures of value, what you tend to get are very defensive businesses, the utility stocks, Wisconsin Energies, that Bob mentioned. You also get a lot of companies that, for the most part, aren’t going to change in the environment. You know, I’m going to go out regardless of how strong the economy is tomorrow, regardless of whether the market takes a 5% dive in the next couple of days, I’m going to go out and buy the same brand of cereal that I’ve bought for the last 10 years, because that’s what I do. I may not, however, buy the brand new iPhone that came out today. I may push that purchase off a little bit.
And so, you look at a company like Apple, it’s going to be much more susceptible to those market swings than, say, a company like General Mills who’s producing that cereal that you buy.
I think this is one of the under-arching themes of what we’ve talked about as well is that active managers provide us with exposure to maybe some of those less traditional measures of value.
There’s a shop that we work with out of Columbus, Ohio, that talks pretty regularly about their approach to value. And it has nothing to do with is this stock cheap relative to its book value? That’s really easy to figure out. You look at a balance sheet, and you can get that number pretty simply. Anybody can do that.
What they do is they look at the company itself, and they try to establish what are the ideas worth? What is management doing to build the intrinsic value, the underlying worth of this company, and can I get it for a fair price relative to that intrinsic value?
And then, obviously lastly, I think a balanced portfolio needs more than just that one measure. The indexes play an incredibly important role. They keep costs down for investors, which is a very important thing. They provide exposure to those defensive names. They provide exposure to dividends. What they don’t do is think outside the box. What they don’t do is provide broader exposure than what you’re going to get based on just that one rule. And so it’s about more than one measure.
You know, that slide that I had to go back to, which slowed me down a little bit here, it’s often accompanied by a story from Bob about The Tortoise and the Hare. You think about the value stocks as the tortoise in that story, the slow and steady. And you think about the hare. You know, that rabbit often led the race. What it didn’t do was finish the race.
And so, the growth stocks are going to have their moment in the sun. They’re going to have their times when they’re far ahead of what you’re getting from value—as they have for the last few years. But remember that the race isn’t over. And remember that that tortoise is still moving along. So those dividends, those defensive names, the different approaches to ideas of worth are the thing that’s going to help carry your portfolio as much or more than those growth stocks have over the long run.
(initially posted October 4, 2019)
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