Patient capital

People are generally too impatient. Unfortunately, this doesn’t serve them well.

Whether chasing crash diets, miracle cures, or playing the lottery, most people want quick fixes. They understand that longer term paths to success–eating less and exercising more–work, but they aren’t willing to put in the time and effort to succeed. They want results NOW, so they end up with results alright–bad results!

One reason people do this is they get fooled by randomness (to use Nassim Taleb’s phraseology). Short term solutions sometimes appear to work, and long term solutions sometimes appear not to work. Luck and timing plays a much bigger role in the short run, and this throws people off. If they were more patient, they’d figure out what works over the long run and stick with that instead of chasing quick fixes.

This phenomenon is readily on display with investing. Value investing–making investments with low price to fundamentals (sales, assets, earnings, book value, etc.)–consistently beats growth investing–high price to fundamentals–over the long run. But, randomness leads growth to sometimes out-perform value for a period, which leads impatient investors to chase what is “working” in the short run. They begin their chase only to find value out-performing growth yet again.

Why not just be a value investor through thick and thin? Because it requires a lot of patience.  

Just like people jump into fad diets, they won’t stick to value investing because it isn’t “working” right NOW. After all, it’s hard to stick with something that isn’t working, especially because this under-performance can go on for years (the last 7 being a good, but not historically unusual, example).  

But, just as night follows day, value investing will win over time, and patient investors will be the one’s retiring on time while their impatient brethren are putting off retirement for a few more years.

Such is life.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Patient capital

Growth vs. Value; “and another thing…”

Another thing that bugs me about the growth versus value distinction is the bad advice that a lot of so-called investment advisers and financial planners give out.

First off, around 85% of financial planners and investment advisers are commissioned-based salespeople. Asking them for advice is like asking a Ford salesman whether you should buy a Ford. You’re not going to get objective advice.

I have no problem with salespeople making a living, but I do have a problem if they don’t disclose how they’re compensated. Here’s a tip: ask any “advisor” how they are compensated and you’ll get a clear picture of whose interests they are serving.

Another problem I have with the advice given out by so-called investment advisers and financial planners is the line that “you need both growth and value investments.” The rationale goes like this: you need to diversify so you will do well regardless of whether growth or value investing is working.

My problem with this “advice” is that mixing most growth and value investments together gives you market returns. And, market returns should not cost you a 5% upfront load plus an annual active management fee of around 1% a year plus an investment advisor fee of 1% a year. Instead, you should just buy an index fund that charges 0.2% a year for market returns.

Want to know why they recommend both growth and value investments instead of an index fund? Because the index fund doesn’t pay a big fat commission for selling their product, and the growth and value mutual funds probably do.

Accepting such advice will help the salesperson make their quota, but it won’t help you reach your goals. Either buy market returns at lowest cost, or find an active manager who can beat the market after all fees.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Value versus Growth; “Boy…I say, I say, boy…ya do’in it all wrong!”

One of the most pernicious fallacies spread in the investing world is the difference between value and growth investing.

Growth investing is usually described as the opposite of value investing.

Growth investing is supposed to be the practice of picking investments with rapidly growing earnings and/ or sales with no focus on valuation.

Value investing is supposed to be the practice of picking “value” investments with low statistical indications of value, like price to earnings or price to book value.

The problem with this method of categorization is that it sets up a false dichotomy. Growth is a vital input to valuation. Some practitioners may ignore growth, but by no means do all value investors ignore growth. Neither do all growth investors categorically dismiss valuation as irrelevant.

It makes no sense to me why any investor would ignore either value or growth. For starters, like I already said, growth is a key input to valuation. A company is worth its future cash flows, so you need to know what those cash flows are and how they will grow to arrive at value.

A growth “investor” that ignores value is not an investor, but a speculator. If you haven’t assessed where price is going and why based on valuation, then you are speculating (a.k.a. guessing) what will happen instead of assessing what can reasonably happen.

Growth and value investing are not opposites, they are different sides of the same coin. The people trying to draw strict distinctions between the two either don’t understand valuation, or they’re academics trying to over simplify investing so they can use computer models to do testing.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The problem with deep value investing

If you’ve read much about investing, you may have heard that value investing beats growth investing over the long run. Numerous studies have shown this in detail. Basically, buying low price to fundamental stocks beats buying high-flying, glamour stocks. But, that’s not the whole story.

I was reminded of this, recently, when I was reading David Swensen’s book, Pioneering Portfolio Management. Swensen has been managing Yale’s endowment for almost two decades and has been generating great returns, so what he has to say should be taken quite seriously.

Swensen warns against just being a deep value investor. What he says is that deep value investing does great until the proverbial 100 year flood comes along. At that time, low price to fundamental stocks get crushed because they tend to be lower-quality, fundamentally riskier businesses.

Deep value investing works like this: poorly performing companies have very poorly performing stocks. People who buy these stocks at super-depressed prices (deep value investors) get great returns as long as the 100 year flood doesn’t hit. In other words, they get great returns for bearing the risk of a flood as long as this isn’t the year a flood comes. This makes value investors’ records look extraordinary–until the flood.

When the flood hits, such portfolios get wiped out! Jeremy Grantham’s (of GMO) research on how these investments did during the Great Depression is revealing. From 1929 to 1933, high price to book stocks (higher-quality, growth-oriented stocks) declined 84.3%. In contrast, low price to book stocks (lower-quality, value-oriented stocks) declined 93%. This may not sound like a big difference because they both did terribly, but an 84.3% loss requires 640% growth to get back to break-even whereas a 93% loss requires 1,430% growth to get back to break-even. Put differently, that’s a 9.7% annualized return for 20 years for the growth stocks versus a 14.2% return for 20 years for value stocks! When the flood comes, you don’t want to be in deep value stocks.

Does this mean that value-investing isn’t the way to go? Not at all. It just means that buying something simply because it is statistically cheap doesn’t mean it will do well in all situations. Just because it has done well doesn’t mean that it will continue to do well. Unless 100 year floods are a thing of the past or you can predict them with great accuarcy, you probably want to make sure your portfolio isn’t filled with deep value stocks.

When evaluating investment managers, this method of investing issue becomes critically important. Looking at someone’s 10 or even 20 year record isn’t enough. You have to know more about the process they use. If Investor A has earned 18% returns by investing in deep value stocks, and Investor B has earned 15% returns by buying good companies below fair value, you may actually want to go with Investor B. That is, unless you know how to predict 100 year floods…

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.