VD 108: Value Stocks vs. Value Investor
Value Stocks vs. Value Investor
There is a general consensus on what value, quality, and growth stocks are.
Growth stocks are, not surprisingly, companies that are growing rapidly, often with revenue growth of more than 20%. Whether they are currently generating profit is not directly relevant for the classification, although that is of course a different story for the investor. The crucial factor is a large market in which the company can continue to grow for a long time.
Everyone dreams of discovering the next Apple, Amazon, or Microsoft at the beginning of their growth trajectory. The idea is simple: if you select that one big winner for the next twenty years, those phenomenal returns will more than compensate for the poor performance of the growth promises that fail to deliver.
With quality stocks, one buys the winners of today, expecting them to keep winning tomorrow. These are companies that have already proven to achieve solid growth (albeit slightly slower) and earn a solid return on it. The ROIC (Return on Invested Capital) is the ratio that receives the most attention here.
Value stocks, according to that same black-and-white ratio, are often defined as stocks with a low price-to-earnings ratio or a low price-to-book ratio. If you look at factor funds or ETFs that focus on ‘value’ or ‘growth’, you will see that they use such quantitative parameters for their selection. It is also these classifications that are used to compare long-term strategies. And it is precisely these comparisons that have led to value investing being labeled as ‘passé’ in recent years.
However, it is a misconception to see a value investor as someone who only invests in cheap price-to-book companies. A true value investor examines the fundamental value of a company and strikes when they receive significantly more value than they pay. Quality and growth are simply components of that valuation exercise. As Charlie Munger said:
“All intelligent investing is value investing.“
That, of course, makes the term ‘value investor’ somewhat hollow; in that view, growth and quality investors who do their homework are actually value investors too.
For me, the distinction lies elsewhere, namely in the willingness to pay a certain price and the required margin of safety. This stems from a difference in vision on the predictability of companies.
For example, I am not looking for the stocks that turned out to be the ‘right’ ones twenty years from now. Due to my background in photography and telecom, I realize all too well that making predictions for a period of five years or more is virtually impossible.
Every year we set plans and goals, and not a single year did we even come close. Every entrepreneur will recognize this. During a year, things often turn out differently than expected. A crucial employee leaves, a project is delayed, a large order comes in unexpectedly, or the tax system suddenly changes. The larger the company, the smaller the impact of one such event, but there are hundreds, if not thousands, of these events daily at these large companies.
If you cannot predict your own sector on an annual basis, you should not have the illusion that you can accurately do this for large multinationals over several years. Planning is essential to achieve something, but they remain plans, not certainties.
The difference between a value investor and a growth or quality investor for me is that we do not gamble on who the winners will be in 20 years. I look for a portfolio of stocks that, on the combination of growth, quality, and price, form the most attractive investment for the next two to three years.
Does this mean I do not want to hold stocks for twenty years? Of course, I do, provided they continue to score well on that same combination throughout that period. For example, Sipef has been almost continuously in my portfolio since 2009, and I bought Ackermans & van Haaren back in 2008. However, I have increased or decreased positions in the interim because the price relative to the calculated value fluctuated, which sometimes made other opportunities more interesting.
A value investor does not blindly chase low ratios. A value investor determines the actual value through thorough fundamental analysis and wants to pay significantly less for it. As Steve Mandel aptly put it:
“I don’t need an analyst to tell me when a 10 PE stock is cheap. I need an analyst to tell me when a 40 PE stock is cheap.“
The value investor is convinced that price matters, something we are seeing again in the market now. People blame AI, and terms like ‘Saasapocalypse’ are flying around. Yet, almost every investor I speak to is convinced that software is not doomed. The recent price drops are not because investors fear these companies will fail, but simply because the prices were no longer in proportion to the reality of profit and growth.
Perhaps ‘rational investor’ is a better term for what we do: determining a value as soberly as possible.