Value versus Growth Investing

November 16, 2020

BY Alexander Kalis

This article first appeared in Capital, The Edge Malaysia Weekly, on November 9, 2020– November 15, 2020.

FOLLOWING the sharp correction in early March this year, the strong earnings growth prospects of the glove and healthcare sectors led to the euphoria in the local stock market between June and August, lifting Bursa Malaysia’s daily trading volume to new records.

A low interest rate environment, coupled with the loan moratorium factor, tempted many savers to move cash into equities. As investors hunt for yield, the focus has been more on growth, not value. The higher stock prices go, the more compelling they become to many.

Notably, in an October report, titled “Is value investing really dead?”, Schroders fund manager Nick Kirrage pointed out that the last few years, especially this year, have been undeniably tough for value investors.

“In the past few years, compared with market indices increasingly dominated by bond proxies or tech stocks, value-style portfolios have underperformed. In fact, growth investing has outperformed value investing for so long now, some are beginning to wonder if it will ever end,” he wrote.

Briefly, value and growth are two fundamental styles of stock investing adopted by fund managers. A value investor seeks stocks that appear undervalued while the growth investor looks for companies with strong earnings growth.

Citing data from California-based investment management services firm Research Affiliates LLC, Kirrage highlighted that the return on equity (ROE) of American value stocks lagged growth stocks by 11% between 1968 and 2007. Since then, it has deteriorated marginally to 12% (see table).

For sales growth, however, the difference between value and growth has actually narrowed from 8% to 6%, favouring value.

Suffice it to say that US and Malaysian growth stocks have generally outperformed value stocks over the past decade or so, although Malaysian value stocks did appear to have regained a bit of superiority over the last three months (see charts).

As the six-month loan holiday ended on Sept 30, investor sentiment has now turned cautious with many adopting a wait-and-see approach or reducing their positions due to the uncertainty over the US presidential election.

Considering that investors are becoming more rational after the rally, will value investing be the way to go instead of growth?

P/BV and PER are less insightful

Singular Asset Management founder and chief investment officer Teoh Kok Lin, manager of the Milltrust Singular ASEAN Fund is not particularly concerned about labelling himself as a growth or value purist.

“At our core, we are driven by fundamentals. We seek to holistically evaluate a company’s core competencies, management quality, business model, industry structure, competitive dynamics and sustainability,” he tells The Edge.

Teoh opines that this underlying approach to uncover investment opportunities generally does not change, whether a company is trading at a high or low multiple, growing fast or slow, or deriving value from mainly tangible or intangible assets.

Going by value investing’s academic definition, value stocks are companies which are deemed undervalued against their future worth. Therefore, the stock price of a company is considered relative to some proxy for value, usually book value or earnings.

Teoh notes that traditional metrics such as price-to-book value (P/BV) and price-earnings (P/E) ratios — deemed attractive when low — are largely based on the concept of mean reversion, which suggests that extreme valuations will revert towards a long-term average.

“Everything has to come at a reasonable price. However, given the shift from manufacturing to service- and tech-based economies, we think that simple value measurements using P/BV and P/E multiples have become less insightful,” he warns.

Today, says Teoh, much more value is created from investments in intangible assets, namely patents, brands and customer acquisition, instead of historically, just from physical assets such as factories.

However, not all intangible assets are deemed assets by accounting rules, and as such, spending to generate these intangibles is written off as a cost item in the income statement.

“This means that companies which invest heavily in intangibles may appear overvalued on a P/BV basis despite these assets driving future profitability,” he explains.

While growth and value are often pitted against each other, there are many factors driving share price performance beyond classification.

The stock market goes through cycles of varying length which favour growth or value strategies, says Teoh.

“Even if growth has outperformed value as a group, we have seen selective divergences from the overall trend. Some stocks can be interchangeably classified as growth or value with overlapping characteristics. Some growth companies may show attractive valuations after adjusting for uncapitalised intangibles. A stock can also evolve over its lifetime from value to growth, and vice versa,” he says.

Teoh goes on to say that there are good investment opportunities in well-managed companies, whether driven by industry structural tailwinds, embracing digitalisation in business models, or strong environmental, social and governance (ESG) alignment.

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