Putting The Economy Back on Track
PUTTING THE ECONOMY BACK ON TRACK —- NO MORE FREE LUNCH!
Historical relationship between Value Investing and Growth Investing
The above referenced chart demonstrates the comparative return strategies of buying low price to book value companies (the proxy for U.S. domestic value equities) versus buying high price to book companies (the proxy for U.S domestic growth equities) from December of 1926 to December of 2022, assuming one starts investing in each strategy with $1. One may wonder at these figures given the popularity (and outperformance) of growth stocks vs value stocks since 2009. This article will explain the differences in the two investment strategies as well as to explain why Hemispheres Investment Management is a value-focused investment manager.
The essence of value investing is buying stocks at a price that is less than the intrinsic value based upon fundamental analysis. The value investor utilizes such metrics as a price-to-book value or price to earnings multiples, including high dividend yields. The discount of the market price to the intrinsic value is what Benjamin Graham called the “margin of safety.” Hemispheres Investment Management looks at these metrics as well as factors such as earnings and sales growth stability. The firm also looks at asset quality, debt burden and the ability of a company to service that debt as well as its access to external capital should the need arise. Hemispheres Investment Management assesses competition in the marketplace, market share, the regulatory and political outlook, and many other factors when we make our investment decisions. Hemispheres Investment Management buys market leading/high quality companies at discounted prices.
Growth companies are richly valued companies that have the potential to grow at a rate that is expected to be higher than the market average. Larger companies typically pay dividends to their stockholders, but growth companies will often reinvest all or most of their cash flow (if they have positive cash flow) in an effort to grow the company. Higher growth potential is often assumed because the company may be offering a unique or advanced product that is ahead of the competition’s products. These products and services may or may not result in long-term success. Growth companies’ expansion since 2007 was largely funded through external financing versus operating profits, cash flow and tangible assets, and many of these companies have never operated at a profit at all. Because of near zero interest rates, low inflation and easy credit generated through the Federal Reserve’s long-time quantitative easing program; investors had a difficult time determining appropriate stock prices and were therefore willing to assume greater risk than historically reasonable. This resulted in a speculative bubble.
This difficulty in determining an appropriate growth-stock price can be demonstrated by evaluating Rivian Automotive, Inc. (RIVN), an electric car manufacturer. In November of 2021, RIVN’s stock traded at $172/share, or an equity market valuation of over $150 billion. For the fiscal year-end 2021, Rivian operated at a loss of $4.2 billion on sales of $55k (yes $55,000) with about 3,200 employees. By comparison, General Motors (symbol GM) in November 2021 had an equity market valuation of $89 billion and over $10 billion in profits in 2021 with 167,000 employees. Per Bloomberg, GM is expected to earn about $11.5 billion in 2025. In 2025, Rivian is forecasted to lose $3.1 billion as the company continues to operate at a loss each year. Rivian is a “growth stock” and GM is a “value stock.” Not surprisingly, RIVN is currently priced around $21/share. The poor 2022 investment performance of growth stocks relative to value investing demonstrated what happens when interest rates start to normalize, and fundamentals reconnect with price discovery.
Because the Federal Reserve continues to raise rates to bring inflation back down to its 2% targeted level as well as through adoption of a policy of quantitative tightening to shrink its balance sheet by $100B per month, credit is tightening. The importance of investing in entities that have a “margin of safety” has never been greater.
Hemispheres Investment Management is a Global Equity and Bond manager with each principal having over 30 years of investment experience. By investing globally, we offer our clients the ability to diversify their portfolio by sector as well as by country, all while investing in leading/high quality companies at a discount to their intrinsic value.
We would be happy to assist you with your investment needs.
Rebecca Holden, CFA
Director of Domestic Research
Hemispheres Investment Management, Inc.
Michael Hart, CFA
Hemispheres Investment Management, Inc.
February 3, 2023