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What Happened to My Value?


Most investors are familiar with the value versus growth story since the global financial crisis, with growth stocks easily outrunning value stocks. This trend has recently become more acute in the US: if you slice the S&P 500 index into growth and value segments, growth has outpaced value by about six percentage points (give or take) over the last year and 3 years (as of 3/31/19 according to Morningstar), a very healthy margin. But it's also a global phenomenon: looking at MSCI indices for international developed ("EAFE") and emerging market ("EM") stocks, growth has been winning a lot in those geographies as well. In fact, the only trailing time period (inclusive of the last 10 years) for which value wins in any of the three major index geographies (US, EAFE, EM) is EM over the last 12 months where value stocks declined less than growth.


A lot has been written about this trend in recent years. Value advocates have often cited media headlines touting "the death of value investing" as a classic contrarian indicator and evidence that the tide is about to turn in value's favor. But they're still waiting. And the factors that have likely led growth outperformance (e.g. lower global GDP growth generally, and the rapid emergence in the last decade of technology industries and businesses with "winner take all/most" characteristics) are unlikely to abate any time soon.


Some in the value camp were optimistic about the Q4 sell-off in stocks. That air pocket - where US indices were down about 20% from September highs with growth down more and value down less - seemed to bring hope that the tide might turn for value. Alas, that "outperformance" was short-lived with growth/technology stocks leading the sharp rebound since Christmas, and those calling the end of value's decade of misery have been made to look silly again.


For us, it's not about how you break apart an index and what gets defined as value and what gets defined as growth. We prefer to look at situations and opportunities on a case-by-case basis using two simple rules:

  1. Don't lose money

  2. Find investments offering a "margin of safety," that is, a material gap in price and value

For the second rule, the price part is easy - price is readily observable, either via exchange (public) or offered price (private). The second part is hard, as it involves making a handful of key assumptions to calculate, conservatively and approximately, the value likely to be delivered to the owner of the investment over time. That value is generally delivered via a stream of cash flows. Businesses generating rapidly growing cash flows for owners are (obviously) highly desirable.


But it's not the rate of growth that matters - it's the rate of growth reflected in the offered price. If price implies a very high rate of growth necessary to achieve a desired rate of return, then a margin of safety may be missing, and the probability of losing money may be too high. On the other hand, even healthy growth expectations may understate true potential, and keen analysis may determine that despite the healthy growth expectations a margin of safety does exist. Of course, history is littered with plenty of examples of the former ("nifty fifty" of the late 1960s; US large cap and TMT in the late 1990s) as investors have tended to overpay for long-term growth with less than flattering results. More recently, we've seen examples of the latter, where the scale and network effect characteristics of certain technology companies have underwritten strong and durable growth rates.


Part of the challenge recently for investors who focus on not losing money is that other investors have attached enormous residual value (value that is delivered to owners far into the future) to technology companies, which often generate little current cash flow. Simultaneously, other investors have ascribed very little in residual value to many companies that currently generate significant cash flow today. That translates into high implied growth rates for tech, and low implied growth rates for many other industries.


While price and value always matters to some degree, price matters less in venture capital and value (or the rate of growth of that value) matters a lot more. If a business has the potential to double in value every three years for the next two decades, then it doesn't really matter whether you paid $10M or $50M for the business - either way, you win big.


Ultimately, we are style-agnostic. We'd always prefer to own a growing business, but we want to do so at a price that allows for some bumps in the road while still delivering acceptable return on investment. Meaning, a price that affords a margin of safety. Meaning, less chance of losing money.


Don't lose money. Margin of safety. Simple rules that can be very effective in the long run.

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