Why talking about ‘Value versus Growth’ is too simplistic
- When we describe ourselves as Contrarian Value investors, we mean we are buying something, and we are getting more than what we paid for
- Our job is to understand what the likely changes down the road could be and assess who is likely to win and lose against this backdrop
- It’s also very important to separate cyclical from secular change
People often hear value investing and assume it’s just an investment with a low P/E ratio, or owning the shares of a proven business in perfectly cyclical industries that don’t have much growth.
However, according to Steve Romick, Portfolio Manager at FPA which is known for its Contrarian Value investment philosophy, this need to pigeonhole investment approaches into “growth” versus “value” is ignoring some important nuances.
“When we describe ourselves as Contrarian Value investors, we mean we are buying something, and we are getting more than what we paid for. That might be because a good business is facing a cyclical challenge or because investors don’t fully recognise the quality of that business. Either way buying such a mispriced asset should result in a rate of return that is better than the market as a whole,” says Romick who is also the Fund Manager of the Nedgroup Investments Global Flexible Fund.
“We want to own growing businesses. We want to own them and buy them at a price that can offer a margin of safety that protects our capital in the event that all does not go as planned. Traditionally that protection comes from a company’s balance sheet - that is, buying below book value for example - or maybe getting some unrecognised real estate value or some other hidden asset.”
However, Romick says blindly practising this traditional approach to value investing is dangerous - particularly today - as many of those types of companies have been disrupted by some of the most prolific technological innovations the world has ever seen.
“Value investing has morphed over the years. If we didn’t evolve with the rapidly changing landscape and recognise that a margin of safety could be established by understanding and properly evaluating a business and not just its balance sheet, we wouldn’t feel that we would have a lot to offer our investors today.”
Romick says they prefer not to anchor themselves to a narrow definition of what value investing is. “Our job is to understand what the likely changes down the road could be and assess who is likely to win and lose against this backdrop. It is as important to avoid the losers as it is to find the winners, but it’s also important to avoid overpaying even for a really great company. A winning business does not necessarily translate to a winning stock. Microsoft stock for example was lower in 2009 than it was in 1999 even though it delivered high-teens growth along the way. Price matters and that is one thing that will never change for us.”
It’s also very important to separate cyclical from secular change. Romick believes that much of what has happened in the last year has been cyclical. “We are living in a world where a global pandemic has stopped many businesses in their tracks, but at the same time many businesses have benefitted from the changing environment.
“Video stream, for example, was already growing quickly before the pandemic and has taken more share from traditional media as people have been forced to find ways to entertain themselves at home at the expense of movie theatres, broadcast television and cable networks. We are constantly forced to examine what businesses are more likely to thrive a decade from now and those that could be struggling,” he says.
The world has changed a lot in the last 15 years. So as people looking to invest capital, protect capital and deploy it, one has to be continuously learning and respectful of what’s going on in the world. Romick says there are a number of businesses that FPA owns in the digital space, some of the internet platform businesses for instance, that didn’t exist really as scale businesses 15 or 20 years ago.
“Today, they, along with many others, are among the best businesses when you consider them from a return on capital perspective or if you think about businesses that have zero marginal cost to acquire a customer. Those are ideal business models where incrementally you generate revenue and profit without expending economic effort and that all falls to the bottom line.
So those types of businesses need to be considered through the eye of how they operate. Now we’ve always done that – we consider banks and financials differently to how we would consider a medical device company for example. We look at different metrics, we look at different margins, we look at different drivers through the financial statements to think about value or to think about sign-posts. And that will continue to evolve. It’s about us observing and participating in what is a dynamic world.”
For Romick and his team, when it comes to finding value there are a couple of key points: that price matters; and the margin of safety matters. So that’s a framework and an intellectual approach that FPA will apply to an individual company as well as a portfolio at large.
“That’s something that’s evergreen and underpins any sort of sensible investing.”