A recurring theme in financial markets is the division between “growth” and “value”, two key styles of investing that are always pitted against each other. In recent years the growth style has outperformed value. Value funds have shrunk in size, while growth funds have topped the performance charts.
However, there is more to this story than the two styles, and the crucial point is that the type of investing deemed value has come to be defined in an overly rigid and ultimately unhelpful way. We consider ourselves value investors and we have managed to outperform while the value style has underperformed.
How it all began
The explanation starts with the capital asset pricing model (CAPM), which was introduced in the 1960s to explain the expected, or required, return of a stock using the anticipated market return, the stock’s beta (relative volatility) and the risk-free rate (typically defined as the inflation-adjusted bond yield matching the duration of the investment in question).
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Then in the 1990s, renowned academics Eugene Fama and Kenneth French added two “factors” to the CAPM to create the Fama-French three-factor model: these were market capitalisation (known as the “size factor”) and price-to-book value (known as the “value factor”).
Further developments have added others, such as the recently successful “growth factor”. Growth and value have thus come to be seen as both distinct and mutually exclusive, which is a problem for genuine value investors who may find themselves pigeonholed as having a value style when they don’t.
Value investors do not necessarily have a style – they just buy stocks when the current price is below their estimate of its intrinsic value (doesn’t everyone do this, you might wonder?). In contrast, the value factor advises buying any (and every) stock that has a low price compared to book value. While these are not entirely different concepts the gap between them is wide and explains the disparity of investment results among value investors, even as the value style has consistently underperformed in recent years.
Where to look now
Take Humana (NYSE: HUM), a US health insurer focused on older people. It has a reasonably strong exposure to the value factor, but it has risen significantly since we bought the stock, despite the overall underperformance of value. The next few months might be affected by the ebbs and flows of the US presidential election, but the longer-term outlook is attractive given the likely growth in the size of their target market as the population ages.
In contrast, Network International (LSE: NETW), a Middle Eastern payment processor with a very strong market position, is apparently underexposed to value. We are not worried about that, though, as our projections for future cash flow tell us that the stock price is below a conservative estimate of its intrinsic value.
Another value stock is Comcast (Nasdaq: CMCSA), the cable and satellite TV network owner and broadcaster. We think its broadband subscriber growth and profit margin trends point to a positive contribution to our investment performance in the future even if the value style continues to underperform.
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