In praise of dull – Boring can often be viewed as a sin but not in the world of value investing
Boring may be the last thing you want to be faced with at a party or across a dinner table but, in the world of investment, the quality is by no means so undesirable. Committed value investors have been aware of this – and been rewarded by the knowledge – for decades now but is there actually any science underpinning the idea that boring can be a positive?
Apparently so, according to a working paper published earlier this year by the US-based National Bureau of Economic Research (NBER), entitled "Are firms in ‘boring’ industries worth less?" Spoiler alert – the paper’s authors conclude that they do tend to be valued more cheaply by the wider market but that, of course, is good news for any investors prepared to swim against the tide.
So why should it be that boring equals cheap in investment terms? The paper swiftly compensates for its layman-friendly title by introducing what it calls the “industry saliency hypothesis”, which essentially looks to judge the degree to which an individual industry sets the pulse racing by the dispersion of the profitability levels of the businesses within it.
Thus, if an industry contains a number of businesses that make a lot of profit but also a number that make a lot of losses, the paper argues that the wider market is likely to view it as exciting. Should all the businesses in an industry achieve pretty much the same level of profitability, however, then the chances are that the wider market will consider it to be boring.
After analysing US stockmarket data from between 1963 and 2010, the paper identified 49 distinct industries and you may not be wholly shocked by the identity of either the sector with the highest dispersion of profitability levels or the lowest. Computer software won the excitement stakes, with three and a half times the dispersion of the most boring sector … utilities.
The paper then went on to analyse whether a firm’s price-to-book ratio bears any relationship to the profitability dispersion of the industry the firm is in. For all those interested in the precise maths involved, you have the link to the paper above; for anyone willing to forego that experience, the paper describes the relationship as “statistically highly significant” and “economically large”.
This seems somewhat counterintuitive. After all, you might expect investors to set some store by the certainty of returns on offer from an industry and yet, what the NBER paper suggests is that the market tends to prefer those sectors with a higher dispersion of profitability levels – indeed, that the higher the breadth of potential returns from that industry, the higher the valuation it places on it.
When things are this counterintuitive, it often helps to turn to behavioural finance for an explanation and, of course, the explanation here lies in human beings’ fascination with get-rich-quick stories. Sectors such as computer services are full of great fortunes being made and, while they are also full of great fortunes being lost, many investors will be inclined to focus only on the former.
Keenly attuned as it is to human nature, the media reinforces all this with its breathless coverage of the big success stories – Apple, Google, Netflix, Tesla and so on – more coverage leading to greater interest in the associated industries and, ultimately, to higher valuations across them. Just not, as the NBER paper acknowledges – and as value investors have always known – to higher long-term returns.
Fund Manager, Equity Value
I joined Schroders in 2004 as an equity analyst in the European Equity Team initially specializing in the Industrial sectors before moving on to Consumer-based companies and finally Insurance. In 2007, I became a co-manager on a fund investing in undervalued European companies and took on sole responsibility for the fund in May 2010. Prior to joining Schroders, I worked at Hedley & Co Stockbrokers and Deutsche Asset Management as a trainee analyst.
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