Last week’s Globe and Mail’s piece entitled, “Why value investing has never been more tempting “suggests that current market conditions may offer some unique opportunities for investors. The debate on value investing is near and dear to our hearts. Many of our client portfolios tend to tilt toward a value approach with less emphasis on the growth style. This has made it tough for portfolios to keep up with the markets in the last couple of years. The gap between the value and growth styles became even more pronounced in the recent market rout just when, theoretically, the value style should preserve capital in a down market. This is even more exacerbated as value underperformed in the market rally following the March 23rd lows.
Generally, value investing means trying to earn more dollars of current return per dollar invested with less focus on what may happen years out. Value investing may tend to have more focus on “less exciting” companies. This doesn’t necessarily mean ignoring technology or healthcare stocks for example, but it might mean owning slightly fewer of them.
The conclusion of the Globe article was that value investing is far from dead and that, generally, value stocks are exceptionally cheap today. In fact, by some measure they’re the cheapest they’ve ever been relative to growth stocks. The current period of value investing underperformance is now the longest since the Great Depression. In 2000, at the height of the tech bubble, a similar phenomenon occurred whereby value stocks were extremely cheap, although not as cheap as today. When the bubble burst, value stocks had significantly positive returns even though markets on the whole experienced significant declines.
There is an excellent example of this is playing out in Canada right now. Shopify, a technology company, just overtook Royal Bank as the most valuable company in Canada. This has happened about four times in the past 20 years. Value investors are almost always underweight in the new highflyer, which can be painful on the way up. Nortel, Blackberry, Potash and Valeant are past examples of tremendous rallies. Of course, none of these companies are larger than Royal Bank today, but most tended to have their businesses run into trouble as well. Perhaps the Shopify example is unfair and theirs will turn out to be a great business.
That said, Shopify has no earnings at the present time. Investors are willing to pay much higher valuations for these businesses purely based on their optimism around the future prospects. Some companies will end up deserving these premium valuations and might grow into them, but in many cases investors get a little over-excited about future growth. And for those companies whose prospects don’t pan out — watch out!
Most importantly, Shopify does not have to fail for value to work. It may very well remain a successful growth company for years. The question really is whether it is priced correctly. What is certain is that Shopify is trading currently at over a 50 times revenue with no profits and, therefore, has a lot to prove. For comparison purposes, a well established and likely to survive business like Royal Bank is trading at 8 times earnings and 2 times revenue, along with a dividend yield in excess of 5%.
Value investing is more than just how to allocate between financial versus technology or consumer products versus oil etc. The whole idea is generally to try and create a discipline to re-balance against the inevitable over-reaction of the market.
For most years and quarters, the ebb and flow between value and growth styles is not that large. Being biased one way or another doesn’t always make a huge difference.
In our view, it is when the pendulum has swung so far from value to growth that it is most important to stay put. Now seems like one of those times.
Steven Belchetz, Senior Vice President, T.E. Wealth
Robert Broad, Vice President & Portfolio Manager, T.E. Wealth
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