Perspective

Markets

Has value investing been disrupted?


Andrew Williams

Andrew Williams

Investment Specialist, Equity Value

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Disruption is a major theme in stock markets today with companies such as Amazon and Uber challenging the traditional approach to their respective industries. Such companies are an example of so-called "growth" stocks, with investors attracted by their prospects for expansion and future revenue growth.

Investors in “value” stocks, in contrast, focus less on a company’s future prospects and more on its current valuation and financial strength.

Critics of value investing argue that, since the technological innovation that is often associated with growth stocks is essential in today’s world, companies without it are unlikely to be the top performers in the future.

Good companies vs good investments

It’s certainly true that older businesses are less likely to be the fast growers of the future. But this overlooks an absolutely crucial distinction between good companies and good investments. 

For example, is UK supermarket chain Tesco being disrupted? It certainly is, due to the expansion of discount retailers such as Aldi and Lidl and the move to food shopping online. However, this didn’t stop the shares going from £1.40 in January 2016 to £2.60 in August 2018. Disruption may stop the shares getting back up to £5.00, but as long as you don’t expect that to happen, you won’t be disappointed.

The broader point in the frothy markets that we are experiencing today is that companies with better technology, higher potential future earnings and the ability to disrupt incumbents do not justify unbounded valuations. They can be very successful businesses while simultaneously being very dangerous investments.

The world is always changing, but that hasn’t stopped the value investment style outperforming for past 150 years. The chart below shows US stocks split by their starting price-to-earnings ratio, and their subsequent 10-year return. A lower P/E indicates a cheaper price. As we can see, the stocks with the lowest P/E (0-7) delivered the highest returns in the following ten-year period.

why-focus-on-cheap-prices.jpg

How can value investors benefit from innovative tech companies?

Value investors can and do benefit from new and innovative technology businesses, but only when they are offered to us at attractive prices. To say value investors cannot benefit from innovation is to view the world through a very short-term lens.

Just as a good business is very different to a good investment, a low price is very different from good value. If, however, you are patient, do your analysis and only buy into undervalued businesses with strong balance sheets, limited amounts of debt and a suitable ‘margin of safety’, then you will give yourself a good chance of outperformance, no matter what value investing’s detractors say.

The stocks of companies that are changing the world, irrespective of their prospects of profitability, tend to outperform in times of optimism as the market pays up for that potential.

Value stocks – businesses with tangible value today – are likely to hold up better in less ebullient times. This is because they are out of favour and therefore attractively valued, and these valuations are based on conservative scepticism rather than hope and faith.

 

The views and opinions contained herein are those of the Authors, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

 

This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

 

Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested.

 

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The forecasts stated in the document are the result of statistical modelling, based on a number of assumptions. Forecasts are subject to a high level of uncertainty regarding future economic and market factors that may affect actual future performance. The forecasts are provided to you for information purposes as at today’s date. Our assumptions may change materially with changes in underlying assumptions that may occur, among other things, as economic and market conditions change. We assume no obligation to provide you with updates or changes to this data as assumptions, economic and market conditions, models or other matters change.