According to some, hunting for stocks that are undervalued as a basis for portfolio selection — commonly called value investing — has been out of favor as former value investors have embraced higher-risk growth stocks.
The idea of researching companies with the goal of buying stocks that are cheap or undervalued was an investing philosophy introduced by the legendary Benjamin Graham, whose most well-known disciple is Warren Buffett.
Value investing seeks to differentiate between the price of a stock and the value of the underlying business. The goal is to ascertain a stock’s intrinsic value, based on an analysis of a company’s current financial condition and its prospects for the future.
The investment principles espoused by Graham held that a share price that is below its intrinsic value is considered a bargain.
Now some argue that the precepts of value investing are no longer applicable as the tech stocks have appreciated substantially since the financial crisis. In many cases tech stocks now operate as market leaders, helping to consistently bring indexes to new highs.
These companies are different in that they are asset-light — they rely on either intellectual property or advertising tech business models.
Yet of the demise of value investing may be premature. Those who contend value investing is irrelevant in the 21st century due to the dominance of the growth or tech stocks sang the same song in the late 1990’s and 2000, during the dot.com craze.
That bubble burst with calamitous effects on those who thought the sky was the limit and traditional fundamental analysis was old-fashioned.
Further, purported “value” funds today suffer from some of the same flaws that Graham warned investors about in the late 1960’s and early 70’s.
Namely, portfolio managers are caught up in the herd mentality and are under constant pressure to dress up their fund’s performance or total return figures to remain competitive with other similar funds.
Often, this entails purchasing individual stocks for the portfolio that traditional value investors would avoid but are now included in the value fund.
Seeking out bargains in the market is in no way at odds of the phenomenal rise of technology stocks. Many of those who argue that value investing is dead base their arguments solely on the performance of the composition of stocks in broad stock market measures, such as the Dow Jones Industrial Average and the S&P 500 index.
There is also the factor of how one defines a “value” stock.
“One of the toughest things is being able to articulate what value investing is anymore,” said Laton Spahr, the portfolio manager of Oppenheimer’s value fund.
Indeed, his value fund has blurred the line between value and growth. Its portfolio has positions in Microsoft and UnitedHealth Group — two equities that are classified as growth stocks.
Purchasing a tech stock that has appreciated dramatically does not, in and of itself, mean it is still not a bargain. The determinative factor is whether its current price reflects the value of the business itself.
This measure is not dependent on the types of assets the company owns. Whether its main assets are intellectual property or advertising revenue as opposed to physical plant and machinery is irrelevant.
Amazon, for instance, is classified as a growth stock. But it could still be considered undervalued if the prospects for its continued earnings growth are not reflected in its current share price.
Another significant factor that were not present during the astronomical rise of the growth tech stocks was the absence of competition, which has created market dominance or a monopoly for each of the companies in their respective industries.
That laissez-faire attitude helped accelerate these companies’ earnings growth. Regulators are now scrutinizing the business practices of Google, Facebook and Amazon in order to ascertain if their rapid growth and business models stifles competition and makes it difficult for start-ups who might challenge their dominance.
Finally, the historically unprecedented zero interest rate environment of the past 10 years fueled the bull market and the tech stocks that rose in tandem.
A long-running low interest rate investment climate skewed asset pricing. Now that the Federal Reserve has announced that quantitative easing is over, bonds are beginning to appear more attractive and the presence of alternative fixed income vehicles for investors will have an impact on the stock market.
Those who claim that value investing is dead based solely on the performance of the stock market during the long bull run should be careful about predicting the future by merely extrapolating the past.
Small-cap winners galoreThe big stock market winners share one common attribute: Near the beginning of the ascent of their shares, the companies offer revolutionary products or services, are market leaders in their respective industries, or both. Some big stock market winners that possessed the attributes outlined above are Netflix (NFLX), which we recommended to investors in October 2002; Intuitive Surgical (ISRG), which we bought and recommended in July 2004; Baidu.com (BIDU), which we bought and recommended in August 2006; and MercadoLibre (MELI), which we recommended to investors in October 2010. Get up-to-date small-cap stock picks from David Frazier, editor of Small-Cap Profit Confidential.
Smarter cryptocurrency investmentsThe stock market crash of 2008 was the catalyst for his journey into alternatives. And interestingly, it was the impetus behind the creation of Bitcoin and the blockchain technology behind it. Keene Little wasn’t ready to risk his money yet but he was very curious, so he began charting Bitcoin’s technical patterns. What finally convinced him to dip a toe into digital currencies was seeing that they followed familiar price patterns that could be analyzed and successfully acted on. Now he shares those insights with subscribers to the Crypto Wealth Protocol.