• Charles Heighton

Value investors have never had it rougher, are the lessons of Graham and Dodd now dead?




By Charles Heighton – The London Financial Markets Editor and VP of Trading at King’s Global Markets


This year has been a comparative catastrophe for those who practice value investing. Value stocks have not performed this badly for at least a century, and they may have never performed like this before.


The average time spent in the index has declined significantly for decades. This shows that companies now get less time to recover due to the increase in successful businesses. Instead of having time to return to normal values, they are removed from the index by the next big thing. Once these companies are indexless, they receive much less coverage from Wall Street and many institutional investors cannot invest in them. This seals their fate as declining stocks. When Graham and Dodd created value investing, companies had time to ebb and flow and investors could bank on them returning to par value. This may longer be the case in our high-octane world. The huge number of businesses that have been established this year may even compound this problem if only a small percentage become successful and go public in the future. The below chart shows the huge increase in new businesses. This could seal the fate of value investing for decades.


Source: https://www.ft.com/content/22fb929c-8b92-4235-bbcf-33378cb66c60


Many reasons have been suggested for this underperformance, the most extreme of them is that value investing is dead. From an objective point of view, this is an overreaction. Ever since its inception value investing has had cycles of success and failure, requiring discipline and patience. This time is not different from any other period of underperformance. It will end. Nothing concrete has changed enough to warrant a gravestone for the value investing method.


Some elements have changed since the days of Graham and Dodd, the founders of the value approach. A clear change is the time companies spend in an index. The below graphic shows the fluctuations in the constituents of the Dow Jones Index since its inception in 1928.


Source: https://www.visualcapitalist.com/every-company-in-and-out-of-the-dow-jones-industrial-average-since-1928/


The average time spent in the index has declined significantly for decades. This shows that companies now get less time to recover due to the increase in successful businesses. Instead of having time to return to normal values they are removed from the index by the next big thing. Once these companies are indexless, they receive much less coverage from Wall Street and many institutional investors cannot invest in them. This seals their fate as declining stocks. When Graham and Dodd created value investing, companies had time to ebb and flow and investors could bank on them returning to par value. This may longer be the case in our high-octane world. The huge number of businesses that have been established this year may even compound this problem if only a small percentage become successful and go public in the future. The below chart shows the huge increase in new businesses. This could seal the fate of value investing for decades.


Source: https://ritholtz.com/wp-content/uploads/2020/10/businessesstarting.jpg


The huge increase in retail investors this year may also have worsened the value drought. These new investors are not analysing companies for value. They are mostly momentum traders jumping on the bandwagon. They do not care for a discounted price to book value or a low price compared to earnings. Depending on who you ask these new traders have inflated the prices of certain tech stocks. This makes the performance of less loved value stocks look even worse.


This all boils down to one question. Is value investing now dead and buried? Personally, as a fan and disciple of Graham, Dodd, and Buffet I think not. However, I am clearly biased.


Only time will tell us if value investing is dead. In the meantime, it might have to evolve as others have suggested to value companies in different ways. Or in five years’ time value may be back and those that stick with it could be investing heroes again.


What do you think? Let us know in the comment section below!

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