Value investing has had a hard decade, but investors who subscribe to its ideology may want to take a leaf out of Bitcoin’s playbook — “value” isn’t how much something costs, but what it’s worth to you.
“When I first left the commune, I was lost. I didn’t know anything else. You have to understand, it’s not like a religion or anything, it’s all I ever knew.”
Now some thirty-five years later, Douglas Pizzaro, a 54-year-old landscaper looks back on his years in a commune, which he was rescued from.
In the Big Sky country of Montana, you can drive for miles without meeting a single soul.
Yet for the thousand-odd people living in the foothills abutting the Rocky Mountains, they could just as well have been living on another planet.
For the followers of the Reverend James Turnbull, that small patch of America was their entire life.
According to Pizzaro,
“You didn’t know any better, I couldn’t even tell you who my parents were. All us kids belonged to the commune and the Reverend was our father.”
“Heck, he could have sired me I wouldn’t know any better.”
For the self-styled preacher Reverend James Turnbull, the ideological struggles of the early 70s presented an opportunity to lead a small community to “build a better life.”
As if following a script that seems to plague so many other cults, the charismatic Turnbull led a motley assortment of misfits from major cities like San Francisco and New York, out into the Big Sky country of Montana, where he promised them the opportunity to build a better society and lives for themselves.
In the early days of the commune, the days were long and idyllic and the evenings interspaced with the preaching of Turnbull.
But as Turnbull’s control over his community grew, so too did his megalomania.
Outsiders were viewed with suspicion and reading literature not written by the preacher himself was deemed “heresy.”
Before long, issues with caring for and feeding so many people culminated in one last act of desperation, the preparation for mass suicide, thwarted by concerned family members of those living inside the commune who alerted authorities to prevent the carnage well before it happened.
Yet the story of Turnbull’s cult is hardly unique and follows the same themes as so many others — a world seemingly in chaos, a charismatic leader, and a promise of a different life.
It may be 2020, but it wouldn’t come as a surprise if new cults weren’t brewing under the current conditions as well.
Investing in Ideology
The investment world is not immune to ideology either and nowhere is this more apparent than in the cult of value investing, where proponents often defend their mantras with a fervor bordering on religiosity.
The only difference between value investing and religion?
You don’t know if you “win” at religion, but it’s a lot easier to keep score of investing techniques.
As news that a potentially world-saving coronavirus vaccine was announced by Pfizer and BioNTech, and Moderna, based on novel mRNA technology, a motley assortment of stocks which had languished under the effects of the pandemic soared on hopes of a recovery.
So-called “value stocks,” companies which are typically asset-heavy and in stodgy industries have had a the worst decade ever.
Whereas “growth stocks,” primarily the shares of U.S. tech firms soared some 225% over the past decade, “value stocks” have only risen by 88% and have slipped 7% this year and has led to a “come to Jesus” moment for value investors.
Value investors are right to worry if they’re worshipping at the altar of the right deities because value investing is in need of a serious upgrade to reflect an economy where intangibles and externalities count for more.
Losing My Religion
To be fair, value investors have had it good for almost a century.
As the dominant ideology in finance, the bible of value investors for the most part has been Benjamin Graham’s The Intelligent Investor, while billionaire investor Warren Buffett has been its pope.
For the uninitiated, value investing typically takes a conservative view of firms, placing more weight on hard assets, cashflows and track record, and less on investment plans or growth trajectories.
Never mind that that’s a bit like driving with both eyes on the rearview mirror, the creed has had no shortage of followers.
Starting in the 1930s, Benjamin Graham proposed that investors adopt a scientific approach when it came to evaluating a firm’s balance sheets and identifying mispriced securities.
That pseudo science was taken up by Buffett, an early Graham disciple who popularized the ideology and updated these ideas for the late 20th century.
But value investing has led to poor results.
While a priest may explain away the lack of a miracle by arguing the deity has not deemed it so, value investors have had to contend with the steadily shrinking value of their portfolios.
An investor who had bought value shares worth US$1 a decade ago would now see those shares fetch US$2.50, versus US$3.45 for the stock market as a whole, and a whopping US$4.65 for the market excluding value stocks.
Even value investing’s pope has not been spared the wrath of animal spirits.
Buffett’s Berkshire Hathaway has lagged the broader market badly.
And despite its efforts to modernize, today, the bulk of Berkshire Hathaway’s market value comes from its substantial holdings in the stock of Apple — a growth company.
Because value investing looks at what “was” as opposed to what “could be,” it’s been largely left out of the rise in technology shares.
Yet investing is fundamentally a forward-looking business.
Nobody invests with the expectation that things will get worse.
There’s a reason why no stock trades at par to its price-to-earnings ratio.
And that’s why value investing is so handicapped by its ideology in identifying future trends and opportunities.
According to conventional value investing wisdom, a typical “value” portfolio would be full of companies from the aviation, energy and financial sectors — the very sectors most badly hit by the pandemic.
And while value investors might argue that they’re the victims of a stock market bubble and will be proved right eventually, that same thinking is what also led hundreds of innocent men, women and children to drink cyanide-laced Kool-Aid.
The problem with value investing is it values what the hands can touch and the eyes can see, in a world that is increasingly valuing the ephemeral.
Intangible assets now account for over a third of all American business investment, including data and research, with firms treating these costs as an expense, rather than an investment that creates an asset, and that throws off balance sheets.
Value investors pouring over these balance sheets are then misled because they often misjudge the capital-creating value of these “costs” and therefore penalize the assessment of such firms.
Yet intangible assets can often be used to scale up a firm’s business quickly and exploit network effects to sustain higher profits.
And the same assessment tools used by value investors also overvalues hard assets like plant and equipment, which is why Buffett loaded up on airlines before the pandemic, only to soon realize that the actual “value” of an airliner that nobody wants is somewhere between zero and nothing.
Using a “value” approach often overprices hard assets like factories, plant and equipment, and underprices things like teams, ideas and innovation.
And value investors can also be blindsided by externalities which often don’t show up in an examination of balance sheets, costs that firms are responsible for, but avoid paying.
Applying the “value” doctrine to stocks today would see an investor loading up on car makers and oil producers, without necessarily factoring in the carbon footprint left behind by these industries and the public shift in attitudes towards transportation and energy.
That’s why stock of Tesla has skyrocketed, whereas legacy car manufacturers have seen their fortunes languish.
And nowhere is the cult of value investing more handicapped then when it’s come to the assessment of cryptocurrencies such as Bitcoin.
How do you value Bitcoin?
Dismissed early on by Buffet as “rat poison squared,” the vermin-killing cryptocurrency Bitcoin, has risen by almost 150% this year alone, and is on track to be the best performing asset of 2020.
And while the rigor and skepticism of value investing is as relevant as ever, how do value investors reconcile their metrics with a nascent asset class that isn’t backed by anything and is essentially unconstrained?
The problem with investing ideologies is that they can, and do, age.
A global pandemic may have been a relatively recent and unexpected phenomenon, but the departure from the gold standard is almost five decades’ old.
Combined with the relentless money printing undertaken by central banks to shore up their economies, it’s more a matter of “when” rather than “if” inflation will come back into play.
And that has seen more money chase more assets, including tech stocks and cryptocurrencies.
But what stymies value investors from assessing the true “value” of cryptocurrencies is that they’re essentially using old world tools to measure new world assets.
“No one tears a piece out of a new garment to patch an old one. Otherwise, they will have torn the new garment, and the patch from the new will not match the old.
And no one pours new wine into old wineskins. Otherwise, the new wine will burst the skins, the wine will run out and the wineskins will be ruined.
No, new wine must be poured into new wineskins.
And no one after drinking old wine wants the new, for they say, ‘The old is better.’”
— Luke 5:36–39
And therein lies the rub.
Because how does one truly value the ability of an asset to in essence “keep score”?
Yet Bitcoin does precisely that.
As a technologically-powered tool of economics, the immutability of the Bitcoin blockchain, the harsh but certain, finality of transactions, and the tamper-proof, pseudonymity of transacting with Bitcoin are all by design, intangible.
Value investing will almost always undervalue Bitcoin’s attributes, while growth investors may simultaneously also overvalue them.
With no plant and no machinery, and nothing tangible to back it, Bitcoin should technically be worthless.
Yet here we are.
If nothing else, the coronavirus pandemic has reframed what “value” means once again.
When your entire reality consists of your immediate four walls, perspectives can change relatively quickly.
Necessities we once deemed “necessary,” don’t necessarily look like “necessities” any more.
The world has collectively learned to somehow live with less of some things, but much more of others.
Just as Benjamin Graham got his start by arguing that the old investing framework of the 1910s had become obsolete by the 1930s, so too it’s entirely possible that the same factors value investors are using to value the new economy may be starting to look a little long in the tooth.