FPA Journal: "Value Investing and the Business Cycle"

[Nords]

This is making the rounds of FundAlarm & M*'s discussion boards. It's always nice to have more support for a confirmation bias.

"Evidence suggests that the value portfolio consistently outperforms the growth portfolio throughout the business cycle." These guys claim that not only is value investing a better performer during down markets, but that it even outperforms during the "expansion" phase of the business cycle.

 

[brewer12345]

Yeah, but since everyone is talking about it and doing it, is the value premium going away?

 

[Slarty]

If you look at Value stocks from about 1995 through 2000 then you'd have missed some incredible returns by not investing in the growth stocks. Value stocks were way out of favor during this period and they did not out perform growth stocks at all.

 

[cute fuzzy bunny]

Considering that time period showed no rationality with regards to investing and their relationship with returns, while its a good point i'm not sure I'd invest differently in the hopes of catching another long wave of irrationality.

I bet growth stocks would do pretty well if they paid a dividend. I'm not sure that whole "we dont pay dividends, we reinvest the money into the business" thing really pans out with the exception of good old fashioned r&d. I've seen how the money is 'reinvested in the business' and you'd be a lot better off giving it to the shareholders.

Even the r&d piece can be pretty dang well overdone. My old company seems to be in business to venture into fairly boneheaded ideas and technologies, only to withdraw a year later. Computers embedded in surfboards. Chip companies making television sets. I'm sure at some point those seemed like good ideas. I just wish I'd been able to sit in on one of the meetings.

 

[HFWR]

I just wish I'd been able to sit in on one of the meetings.

Masochist...

Ironic really that the DMD chip in DLP systems wouldn't have been invented under the current R&D paradigm of "Focused Innovation"...

 

[wildcat]

Yeah, but since everyone is talking about it and doing it, is the value premium going away?

I personally think this is the case in recent years. I think value pays if you can stick with over long periods of time - the last few years have attracted a lot of investors into the value camp and could very well have diminished the value premium. Over time sentiment could change and the premium could return. In other words, wait for everyone to leave the value camp again and just keep DCAing into value funds.

 

[brewer12345]

I personally think this is the case in recent years.  I think value pays if you can stick with over long periods of time - the last few years have attracted a lot of investors into the value camp and could very well have diminished the value premium.  Over time sentiment could change and the premium could return.  In other words, wait for everyone to leave the value camp again and just keep DCAing into value funds.

Or go in search of stuff that doesn't make it into the funds, for one reason or another. I was looking at my portfolio and I realized that I don't own any S&P500 members. Closest thing I have is a single S&P400 midcap member (and this company has been a stellar performer). Everything else is either not a member of any index, has a miniscule weighting in the Nasdaq composite (.003% weighting? is every Nas-quoted stock in the index?), or a member of some index I never heard of.

 

[wildcat]

Ahh yes. I am always thrilled when I see no analyst coverage or incredibly low institutional ownership on a potential investment.

 

[brewer12345]

Ahh yes.  I am always thrilled when I see no analyst coverage or incredibly low institutional ownership on a potential investment. 

You up your chances if you buy really tiny stuff. I have done especially well with really small banks.

I also like companies that produce a lot of cash flow, don't have too many fleas, and have a big short interest. Slightest hint of good news and you are off to the races.

 

[Nords]

Yeah, but since everyone is talking about it and doing it, is the value premium going away?

You would think so, but the S&P600 Small-cap Value ETF (IJS) just set yet another 52-week high. I already took some cash off the table last fall and now it's probably time to cash out some more.

If you look at Value stocks from about 1995 through 2000 then you'd have missed some incredible returns by not investing in the growth stocks.  Value stocks were way out of favor during this period and they did not out perform growth stocks at all.

And how long did we have to wait before 1995 for growth to "catch up"? With multi-decade performance of the value premium we would've ridden out the 1995-2000 "short-term anomaly". And although I (among many others) started to move from value to growth in the late '90s, we moved right back into value a few years later.

If value turned in stinko performance for about three years then I might be tempted to move out of it. But its demise has been predicted for at least the last two years and when the inevitable RTM occurs I wonder if it'll be down or just sideways. Either way Siegel & I will be reinvesting those dividends.

Another case in point, admittedly an isolated one. Brewer pointed out that Eagle Shipping (EGLE) has a huge dividend, low debt, and a low price. It's only been public for about seven months (the lockup expiration is presumably pressuring the price) and it's not followed by many analysts. When you look at the numbers it's a classic value stock trading near its 52-week low. The technicals look great and I've been buying in. However in the last couple months it's lost over 15% of its price to get there. Its fundamentals make it the kind of stock I would've bought at $14, thought I'd missed the boat, and am happily buying at $12. I'll hold it for at least a couple years and those dividends will also be reinvested.

Contrast that with Evergreen Solar (ESLR). I came across them in Peter Lynch fashion while buying their photovoltaic panels. They're getting a great boost from German & Japanese demand (govt subsidies) and the U.S. federal tax credits will apply upward pressure for as long as the next two years. Good thing, too, because the company sucks. It has low margins & no profits, and it's not expected to turn profitable for at least another year. The stock price has more than doubled in the last year (it's about to triple), Cramer gave it an overnight personal 10% boost a couple weeks ago, and it's gone up over 5% in the weeks since I've started buying. Yet I wouldn't keep this stock without a tight sell stop because when the subsidies run out and everyone's bought their commodity PV installation, the party will come crashing to a halt. I'll ride it until it drops and then run screaming for the exits like the rest of the lemmings expert traders.

That's one overlooked feature about the value premium. Its stocks are basically sound companies that frequently pay a dividend, the investments are easy to sleep on, and although they're nice to look at they don't need constant watching.

 

[Arif]

Is there a place on the net that compares the return of different strategies such as value and growth stock investing over a long period of time?

 

[Nords]

Is there a place on the net that compares the return of different strategies such as value and growth stock investing over a long period of time?

I don't think "Four Pillars" is online yet, but you can start by searching through Bernstein's website.

 

[sgeeeee]

But how does the individual investor buy the bottom 20% of stocks ranked by the Sharpe index?

I admit I only skimmed the article, but it wasn't clear to me how they quantified the performance each period. Did they buy the bottom 20% and hold till the end? Did they sell off stock when it was no longer in the lower 20% and buy something else?

 

[Nords]

Did they buy the bottom 20% and hold till the end?  Did they sell off stock when it was no longer in the lower 20% and buy something else?   

Details like that always seem to be lacking. I think they want to keep us in suspense until next month's "Letters to the Editor" or their NEXT research paper...

 

[sgeeeee]

Details like that always seem to be lacking.  I think they want to keep us in suspense until next month's "Letters to the Editor" or their NEXT research paper...

Okay, but that's one of the reasons why I think this paper is of no value. The authors compare one investment strategy that no real investor can actually follow to another investment strategy that no real investor can actually follow. Even if you were inclined to try it and could somehow afford to invest this way, they don't give you enough detail to know what they really did. Then they conclude that one of the unreal investment strategies is better than the other one. They never compare either of them to a realistic strategy or index. For all the reader knows, you would have been better off investing in government bonds than with either of these techniques.

 

[cute fuzzy bunny]

Masochist...

Oh you have me so, so wrong. I'm a sadist when it comes to those who desperately need to be poked with a small sharp instrument repeatedly.

I'd have liked to have been a part of those meetings to dissect the faulty and short term or single dimension thinking, and to see who came to me after the meetings to say they thought the same things but were too chickenshit to say anything. And maybe for the one or two sr. mgrs who would tell me a year later 'you said it, you were right'. If those guys made it to the point of running the company years later, i'd buy stock. They had their eye on the ball.

 

[brewer12345]

Is there a place on the net that compares the return of different strategies such as value and growth stock investing over a long period of time?

There are value and growth splits of the indexes, but I'm not sure how far they go back.

 

[wildcat]

I kind of summarized a similar article as part of a paper I wrote during B-school:

"The cross-sectional study included six different investment styles, ten sectors and international returns. The first cross-sectional study involved investment styles and included: small cap growth, small cap blend, small cap value, large cap growth, large cap blend and large cap value. Interestingly, small cap value equities outperformed all other styles in both expansive and restrictive environments. However, the returns of the small cap styles varied greatly between economic policies when compared to large cap styles. For example, the small cap value style returned 54.54% during the expansion periods and returned 16.68% during the restrictive periods which is good but it suggests small caps experience extreme volatility during changes in Fed policy."