Read on Twitter
1/ There has been a lot of talks about value losing to growth recently. Here is my take on why value is losing and the fallacy of the value investing tribe. For context, I come from a value oriented background (JP Morgan, Hotchkis and Wiley, Pimco, and Oaktree).
2/ Too many value investors simply buy low PE stocks. This type of active strategy no longer work very well for a couple of reasons. One, if all you are doing is buying low PE stocks based on backward looking #'s, the quants and algos can do this much better than you.
...two, in a raging bull market, low PE stocks tend to be shrinking businesses, and buying shrinking businesses haven't worked very well in the current environment. They don't work because most of the FCF generated by these businesses don't accrue to shareholders..
..they typically go towards buying back shares that become "worth less" over time.
4/ Most value investors think about normalized earnings but not the path it takes to normalized earnings. Many value investors I know believe trying to predict the path to normalized earnings is a futile exercise, so they don't think about it.
..This is dangerous because if the path crosses zero (i.e. bankruptcy), you will never get to normalized earnings, no matter how high it is relative to current price. I believe it's a worthwhile exercise to think about the various paths and assign probability for each path..
.. I use this analysis to manage risk and think qualitatively about various outcomes rather than incorporating it quantitatively into my model/target price.
5/ Quite a few value investors tend to think that a dollar of earning is a dollar of earning - it doesn't matter how you generate it. People that think like this end up owning too many companies with cyclical end markets and non-recurring revenue.
.. it seems to me that Greenlight has been doing this recently. Their portfolio is full of low quality cyclical and non-recurring revenue businesses.
6/ A lot of the value tribe also believes deeply in mean reversion investing. The problem here is that you end up always buying the worst company with the worst management team in an industry.
... Though I get that empirically there are evidences showing mean reversion of poor performing stocks. The idea of always buying the crappiest company just seems a bit dumb.
7/ Value investors also don't like to think about macro believing that their bottom-up process will take care of the returns.
..Though I agree that it's very difficult to make money betting on macro, you absolutely have to manage risk through macro analysis if macro affects your cash flow. I see so many value investors buying energy stocks without having any view on energy prices, which is just strange
8/ A lot of value managers have been allocating capital towards the optically "cheap" sectors such as energy, financials, retail and shipping, and these sectors haven't done well in the current low interest rate environment.
9/ Low interest rate hurts value recently for a couple of reasons. One, when rates are low, it's harder for banks to make money and it lowers the future earning potential for the financial sector. This leads to multiple compression and lackluster stock returns..
... value managers unfortunately own a lot of banks. Two, when money is free, it's much easier for companies to add capacities/supply which leads to lower returns for everyone. This is especially true for the commodity industries..
... it also manifests through the venture capital industry. Venture-backed startups are deflationary in my opinion because they don't need to generate a profit and can potentially sell a dollar for 90c. If you are an incumbent competitor, you end up being in lose-lose situation.
... you either lose market share by not competing or you lose profit margin by matching startups' uneconomic behaviors. This hurts value disproportionally as matured companies tend to be valued on their profits.
10/ Lastly, value investors tend to like small cap stocks, and I think small cap public companies are at a competitive disadvantage vs their larger peers over the last decade.
