There’s Value in Value
Early last month Warren Buffett’s much-anticipated annual letter to Berkshire Hathaway shareholders was released. While the glossy management discussion and analysis (MD&A) pages of a company’s annual report may be “glossed over” by the market, the yearly commentary from one of the world’s most successful investors tends to garner a lot of attention. A brief scan of these letters reveals a common theme – adherence to a value investment strategy has been a key factor in Mr. Buffett’s consistent outperformance.
As the term “value” implies, this approach to investing entails buying stocks below their true worth. This is not to be confused with simply “buying low and selling high”. A contrarian, long-term approach is often required due to the fact that companies can remain undervalued for extended periods of time. On the other hand, growth stocks commonly trade at higher valuations, which is usually because they are higher-quality companies exhibiting strong revenue and earnings growth.
Evidence spanning several decades has shown that value stocks often outperform their growth counterparts. Additionally, this “value premium” is not only persistent across time, it is also widespread throughout global markets.
Rolling 3 Year Annualized Returns – Q1 1978 to Q1 2013
MSCI World Value Index Less MSCI World Growth Index ($CAD)
Source: eVestment | T.E. Wealth
The chart above compares the MSCI World Value Index to the MSCI World Growth Index. For each quarter since 1978, the 3-year performance of global growth stocks is subtracted from the 3-year return of global value stocks. While this chart highlights the long-term “value premium”, it also shows an extended period of underperformance since 2008. In fact, value is currently lagging growth for the longest period in the past forty years.
Given this environment, even the “Oracle of Omaha” has been affected. With the S&P 500 Index outpacing Berkshire Hathaway’s value-focused portfolio since 2008, Mr. Buffett conceded in his latest annual letter that his fund may soon report its first ever five-year period of underperformance.
It has been said that while history doesn’t repeat itself, it often rhymes. Market cycles rarely play out exactly as they have in the past, though historical patterns can be instructive. The chart also shows that value strategies trailed during the late 1990s during the technology bubble hysteria. Recall that during this time, conventional investment analysis was abandoned. The market was driven by the single, overarching theme of the dot-com age, which could apparently only move stocks even higher. As a contrarian approach, value investing took advantage of this irrationality. With the weak, uneven recovery we have seen to this point, the main theme driving markets today is the preference for safe, high quality assets. In the US, while the S&P 500 Index has reached historical highs, it is interesting to note that the less risky defensive names in the Health Care, Consumer Staples and Utilities sectors are still favoured. As economic conditions normalize, investors could once again find value in the value strategy.
Instead of choosing just one approach, T.E. Investment Counsel constructs portfolios with a blend of both value and growth styles. This allows investors to potentially gain throughout all phases of an economic cycle, achieving smoother returns with less overall risk. While it is difficult to determine when value investing will come back into favour, the long-term outperformance record certainly provides some comfort. As Mr. Buffett has long advised, the key to realizing the “value premium” is patience.
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