As a 30 year value investor I found this article to be the best thing I have read in some time. My conclusion is not that value investing is dead, but that patient value investing
works best with your own money. Impatient value investing requires luck as well as skill. More rapid style rotation may yet come to the rescue.
That's too kind of you! You might want to suggest reading the linked perception change series next. I believe it truly opens the eyes of old-school value investors to a new way to think in today's environment.
Thank you for writing this! As you know, I grew up on Buffett, Munger, Klarman, and still think like an owner. I just stopped being religious about the old rulebook. Markets got faster, flows got larger, and selloffs resolve in weeks. So I adapted.What I appreciate most is that you did not pick a side. You actually practiced the discipline of holding two opposing forces in tension long enough for something true to come out of the collision. This is one of the best pieces I have read in the Substack finance community. Everyone should read it carefully, word for word.
The inexplicable lack of market reaction sometimes and then very violent moves other times is one thing I have observed and experienced a lot recently.
The interesting part is that all three sources agree on the mechanism and only differ on the wait. That makes this a disagreement about duration, not about whether intrinsic value still anchors price. Duration is also the one variable an outside investor can adjust without changing the analysis.
Been thinking about this for a while and as the length of your post shows, there is A LOT to be said about this topic.
I absolutely don't believe value investing is dead. But predicting short term multiple expansion is speculative at best.
Also it seems vast majority of investors try to find some formula, metric or template that is replicable to all companies to save time and efforts.
But every company is different and every situation is different.
A company could trade at 4 p/e but if you dig deeper you see that the company needs to reinvest all cashflow to maintain earnings. Is such a company really worth more than 4 p/e then ?
I now never pick stocks for which the thesis is based on re-rating. As you wrote, I choose companies that will take care of it themselves.
An example: $BKNG is trading at 16x FCF. Do I think it should deserve a 20-24x multiples? Yes.
Does it matters in my thesis? No.
$BKNG takes a +4% in rooms bookings and translate this into a +15% EPS growth. So even if $BKNG would stick at 16x, I would make 15% return based on EPS growing.
Multiples can then fluctuate between 8x and 30x during my long holding timeframe that I wouldn't bother or be frustrated by markets.
Excellent articulation of value investing and the status quo. Great job getting into the nuances that so often get overlooked due to prevailing soundbites.
I have thought about the problem you describe of price closing the gap to value, and I have two complimentary answers to tackle this.
The first one is the distinction between value and discount rate. Quoting Charlie Munger: “invert, always invert”. I usually pay more attention to the implied discount rate than to value. Why? Consider stock A trading at half of intrinsic value at 10% discount rate, and stock B trading at one third of intrinsic value also at a 10% discount rate. Which one is the best? If you said stock B, you are wrong. The problem is that valuation depends on the discount rate you pick. Imagine that stock A is giving a sustainable 20% dividend yield with no growth, and stock B is growing topline at 11% for decades. Stock A is clearly undervalued by half at an implied discount rate of 20%. Stock B’s valuation depends on what is your forecast window, and the implied discount rate would be between 10 and 11%. I would pick stock A over stock B hands over fist. To make it more ludicrous, stock B’s value is infinite if it can grow forever at 11%!
The second one is that price tends to follow improvement in fundamentals, and negative fundamentals are mean reverting. Mean reversion of fundamentals is easier to forecast than sentiment. I have seen this pattern repeating multiple times and sometimes it tends to pay off quicker than the “quality compounders”. To give you a couple of examples here. Two of my most successful investments this past year have been companies with high operational leverage. Their names are Basic Fit and Stadler Rail. The first one I had the benefit of understanding the business and I bought more at 18€ a share when the market panicked on an announced change of strategy and now it is around 35€. I remember that the stock fell 20% in one day and as analysts reports started coming in, the stock went up with no news and fully recovered in 1-2 months. Market efficiency in question!!!! The second one is embarrassing to admit because the company doesn't look that great, but management was guiding for 50% revenue growth in one year and doubling of margins in the mid term. The market didn't seem to believe this was possible… until recently in this half year. I bought it with margin, borrowing at 1.5% because it trades on CHF, and I will probably sell it in the next 6-12 months for a very expedient profit. The risk was pretty low even on margin because the dividend more than paid for the interest.
I agree with Waterford Capital "Einhorn buys value traps with deteriorating earnings and/or huge overhangs on the terminal value he is ignoring....the multiple is low but companies with earnings that go down generally don't go up. If you buy companies with growing earnings that eventually gets rewarded."
Valuation still works very well, in UK stocks, Colombia, Africa, China, Spain. Heck Kaspi in Kazakhstan got revalued this month!
Allegro in Poland was on a three years downtrend, I bought, it's up 50% from the lows. Just on valuation.
When it does not work its because the business is getting worse and momentum gets negative. But even then you still get some dividends and limited downside.
These people complaining that valuation does not work just buy value traps. I get it, I have and had my fair share of value traps.
Most people don't have the contrarian mindset to buy deep value and keep holding or even adding.
I think they change. The rules of the game change. Valuation cannot be used as it was two or five decades ago. It has value, just has to be used in today’s standards.
You cannot find companies trading at Buffet's requirements anymore for example. If you do, performance won't beat the S&P as most of it is now volatile tech.
Valuations never predicted returns in the past. They never will. Nothing has changed.
90+ years of data shows R² 6% for 1-year returns from valuations. For 5-year? Maybe 32%. That's the ceiling.
What's different now? Nothing.
The rest is still earnings, sentiment, policy, inflation, black swans. Valuation is just one variable in a chaotic system.
The "regime change" isn't about valuations becoming irrelevant they never mattered that much. The regime is that investors believe they matter. That's when the disconnect starts.
Wait for "cheap" in a market that doesn't wait for fair. You're already late.
First I read Substack on an IPad using the app. Really long articles with lots of graphics cause the app to lock up, not display graphics and occasionally abend. It really detracts from your very thoughtful and well illustrated piece.just something to keep in mind.
Second I was reminded of Graham’s comment about short term the market is a voting machine and long term a weighing machine.
One of the things I’ve learned studying investor behavior is the market is not a cohesive groupthink but is in fact a gaggle of voices all talking at the same time and at best we can only hope to pick out a few voices that sound reasonable. And that judgement is a reflection of our own biases.
Besides the passive index distortion of markets there is also the institutional approaches (algo’s, pod shops, extremely large active fund rotations, etc.) that also distort. Dr. Burry did a very insightful article on Pod shops and how their operating methods really skew short term pricing. As best I could understand the people in the pods get shown the door for a trade that falls below a 2% loss so they pull the trigger fast and often, accelerating volatility. I took a few months to go listen to podcasters, read books and articles touting technical trading. It was very interesting to hear what people who could care less about valuation or investing and are just trading, trading trading, it’s worth examining their psychology (or pathos) to better understand short term volatility and momentum. Now back to hearing everyone talking at once, May the loudest fool win!
As a 30 year value investor I found this article to be the best thing I have read in some time. My conclusion is not that value investing is dead, but that patient value investing
works best with your own money. Impatient value investing requires luck as well as skill. More rapid style rotation may yet come to the rescue.
That's quite a compliment! Thank you. I love the terminology you introduced: Im/patient value investing.
I have suggested all the team at Santa Lucia Asset Management should read it.
That's too kind of you! You might want to suggest reading the linked perception change series next. I believe it truly opens the eyes of old-school value investors to a new way to think in today's environment.
Thank you for writing this! As you know, I grew up on Buffett, Munger, Klarman, and still think like an owner. I just stopped being religious about the old rulebook. Markets got faster, flows got larger, and selloffs resolve in weeks. So I adapted.What I appreciate most is that you did not pick a side. You actually practiced the discipline of holding two opposing forces in tension long enough for something true to come out of the collision. This is one of the best pieces I have read in the Substack finance community. Everyone should read it carefully, word for word.
It's probably never a good idea to be religious about anything.
Thanks one more time for commenting Sir!
Excellent piece Rene!
The inexplicable lack of market reaction sometimes and then very violent moves other times is one thing I have observed and experienced a lot recently.
Yes, true. Just look at Adobe right now for instance. If the stock keeps rallying it will have doubled in a matter of weeks.
The interesting part is that all three sources agree on the mechanism and only differ on the wait. That makes this a disagreement about duration, not about whether intrinsic value still anchors price. Duration is also the one variable an outside investor can adjust without changing the analysis.
Been thinking about this for a while and as the length of your post shows, there is A LOT to be said about this topic.
I absolutely don't believe value investing is dead. But predicting short term multiple expansion is speculative at best.
Also it seems vast majority of investors try to find some formula, metric or template that is replicable to all companies to save time and efforts.
But every company is different and every situation is different.
A company could trade at 4 p/e but if you dig deeper you see that the company needs to reinvest all cashflow to maintain earnings. Is such a company really worth more than 4 p/e then ?
I now never pick stocks for which the thesis is based on re-rating. As you wrote, I choose companies that will take care of it themselves.
An example: $BKNG is trading at 16x FCF. Do I think it should deserve a 20-24x multiples? Yes.
Does it matters in my thesis? No.
$BKNG takes a +4% in rooms bookings and translate this into a +15% EPS growth. So even if $BKNG would stick at 16x, I would make 15% return based on EPS growing.
Multiples can then fluctuate between 8x and 30x during my long holding timeframe that I wouldn't bother or be frustrated by markets.
Agree. My personal favorite hunting ground are also businesses compounding intrinsic value at 15%+ which may be underpriced by the market.
Excellent articulation of value investing and the status quo. Great job getting into the nuances that so often get overlooked due to prevailing soundbites.
Thanks yo much Gurpal!
Really well done article. Thanks, Rene!
Thank you, Tom 🙏🏻
I have thought about the problem you describe of price closing the gap to value, and I have two complimentary answers to tackle this.
The first one is the distinction between value and discount rate. Quoting Charlie Munger: “invert, always invert”. I usually pay more attention to the implied discount rate than to value. Why? Consider stock A trading at half of intrinsic value at 10% discount rate, and stock B trading at one third of intrinsic value also at a 10% discount rate. Which one is the best? If you said stock B, you are wrong. The problem is that valuation depends on the discount rate you pick. Imagine that stock A is giving a sustainable 20% dividend yield with no growth, and stock B is growing topline at 11% for decades. Stock A is clearly undervalued by half at an implied discount rate of 20%. Stock B’s valuation depends on what is your forecast window, and the implied discount rate would be between 10 and 11%. I would pick stock A over stock B hands over fist. To make it more ludicrous, stock B’s value is infinite if it can grow forever at 11%!
The second one is that price tends to follow improvement in fundamentals, and negative fundamentals are mean reverting. Mean reversion of fundamentals is easier to forecast than sentiment. I have seen this pattern repeating multiple times and sometimes it tends to pay off quicker than the “quality compounders”. To give you a couple of examples here. Two of my most successful investments this past year have been companies with high operational leverage. Their names are Basic Fit and Stadler Rail. The first one I had the benefit of understanding the business and I bought more at 18€ a share when the market panicked on an announced change of strategy and now it is around 35€. I remember that the stock fell 20% in one day and as analysts reports started coming in, the stock went up with no news and fully recovered in 1-2 months. Market efficiency in question!!!! The second one is embarrassing to admit because the company doesn't look that great, but management was guiding for 50% revenue growth in one year and doubling of margins in the mid term. The market didn't seem to believe this was possible… until recently in this half year. I bought it with margin, borrowing at 1.5% because it trades on CHF, and I will probably sell it in the next 6-12 months for a very expedient profit. The risk was pretty low even on margin because the dividend more than paid for the interest.
Excellent piece. Well done
Thanks JP ☺️
I agree with Waterford Capital "Einhorn buys value traps with deteriorating earnings and/or huge overhangs on the terminal value he is ignoring....the multiple is low but companies with earnings that go down generally don't go up. If you buy companies with growing earnings that eventually gets rewarded."
Valuation still works very well, in UK stocks, Colombia, Africa, China, Spain. Heck Kaspi in Kazakhstan got revalued this month!
Allegro in Poland was on a three years downtrend, I bought, it's up 50% from the lows. Just on valuation.
When it does not work its because the business is getting worse and momentum gets negative. But even then you still get some dividends and limited downside.
These people complaining that valuation does not work just buy value traps. I get it, I have and had my fair share of value traps.
Most people don't have the contrarian mindset to buy deep value and keep holding or even adding.
Fantastic comment
its like your Edenred coverage.. Works perfectly
Great read!
I think too many believe the market is a static place that doesn't evolve and that what worked two decades ago still works.
But economies change. Liquidity changes. The world changes. Things go much faster today and a company's cycle isn't what it was two decades ago.
Things change. The market changes as well.
All true. Yet valuation and its underlying principles are timeless and do not change.
I think they change. The rules of the game change. Valuation cannot be used as it was two or five decades ago. It has value, just has to be used in today’s standards.
It can and it still works
You cannot find companies trading at Buffet's requirements anymore for example. If you do, performance won't beat the S&P as most of it is now volatile tech.
Talking about the U.S. market only.
Indeed, I look for opportunities in Ems only now - Its USA 1960
Then sure, I'll agree with you it still exists outside of the US 🤝
One of the best insight for a while and a great topic to discuss.
Thanks Dawid. Means a lot. Any points you strongly disagree with?
Value Growth Contrarian at the right time leads to success.
.
Value Growth Contrarian at the wrong time leads to disappointment.
.
What drag compounding up: ROIC and Growth
What drag compounding down: wrong time of acquisition
.
Stock investing : Half Luck， Half Valuation
I'm never quite sure what to make of your comments to be honest.
Valuations never predicted returns in the past. They never will. Nothing has changed.
90+ years of data shows R² 6% for 1-year returns from valuations. For 5-year? Maybe 32%. That's the ceiling.
What's different now? Nothing.
The rest is still earnings, sentiment, policy, inflation, black swans. Valuation is just one variable in a chaotic system.
The "regime change" isn't about valuations becoming irrelevant they never mattered that much. The regime is that investors believe they matter. That's when the disconnect starts.
Wait for "cheap" in a market that doesn't wait for fair. You're already late.
First I read Substack on an IPad using the app. Really long articles with lots of graphics cause the app to lock up, not display graphics and occasionally abend. It really detracts from your very thoughtful and well illustrated piece.just something to keep in mind.
Second I was reminded of Graham’s comment about short term the market is a voting machine and long term a weighing machine.
One of the things I’ve learned studying investor behavior is the market is not a cohesive groupthink but is in fact a gaggle of voices all talking at the same time and at best we can only hope to pick out a few voices that sound reasonable. And that judgement is a reflection of our own biases.
Besides the passive index distortion of markets there is also the institutional approaches (algo’s, pod shops, extremely large active fund rotations, etc.) that also distort. Dr. Burry did a very insightful article on Pod shops and how their operating methods really skew short term pricing. As best I could understand the people in the pods get shown the door for a trade that falls below a 2% loss so they pull the trigger fast and often, accelerating volatility. I took a few months to go listen to podcasters, read books and articles touting technical trading. It was very interesting to hear what people who could care less about valuation or investing and are just trading, trading trading, it’s worth examining their psychology (or pathos) to better understand short term volatility and momentum. Now back to hearing everyone talking at once, May the loudest fool win!