BMO’s Julian Cane takes issue with reasoning that suggests that because ‘value investing’ is out of fashion, the performance of the value investor can be excused.
At the risk of offending my fellow investors, I’ve noticed an increasing number of stock-pickers explaining their disappointing performance through style or investment factors as though these are outside their control.
In particular, the recent claim is that “value” investing is out of fashion and therefore the performance of the value investor can be excused – it’s not their fault that the investment background is out of kilter with their chosen style. I think that this argument does not hold and can be exposed from a number of different angles.
What is value investing?
A firm definition of value investing is elusive, and its practice has definitely changed over time.
It’s obviously important to distinguish between price and value; as Warren Buffett has said, “Price is what you pay, value is what you get.” We believe that taking the time to properly analyse the value of any investment before purchase is the best course of action. The price paid for an investment is one of the very few component parts an investor can influence and it’s clearly an important part of the equation that determines subsequent performance.
Value must be about a total assessment of a company’s worth and into that calculation all aspects of the business should be considered. To characterise value investing as something as simple as buying stocks with a low multiple, whether that be book value, earnings, cash flow, sales or something else, is surely a gross over-simplification.
To be clear, I would say that we are value investors, but we put real value on growth and stability of strong returns and look for companies with strong finances. We would never find a company attractive just because it was trading at a low multiple of something or other.
Don’t blame style
Investors who feel that they are out of sync with the market nearly always claim to be stock-pickers. It certainly appears to be how their portfolios are constructed and their reports show the portfolio stock by stock, but don’t generally comment on factor and style exposures. Really, it is the performance of individual stocks that drives investment performance; performance is ultimately about stock-picking.
A simple topical example should illustrate this. Thomas Cook would undoubtedly have been viewed as a “value” stock – the shares traded at a very low multiple of profits and it had substantial turnover relative to its market capitalisation. It certainly had some well-known value-biased investors as shareholders. Can the catastrophic performance of the company’s shares be blamed on a bad patch for value investing? Absolutely not – it was a highly leveraged company, in a competitive sector, facing traditional rivals and internet competition, with a high degree of cyclicality and seasonality.
Its failure will have had a negative impact on value indices, but no investors were forced to own it, so to hide behind an amorphous investment factor would just be wrong. In this case, the dent to performance comes not from style, but stock selection.
The recent crop of profit warnings demonstrate that the current environment is pretty unforgiving. But for all the negative media headlines, we should remember that in the UK, employment is at record highs and interest rates at extraordinarily low levels. If companies are struggling in this environment, and many might crudely fall into the “value” category, I fear that it says more about the strength of their businesses than anything else.
Use mistakes to learn, not blame
Returning to the blame game, there’s another adage that can help in the thought process: “Invert, always invert.” This quote, originally from the German mathematician Carl Jacobi, has been more recently popularised by Warren Buffett’s business partner Charlie Munger. It asks us to think about any statement the other way around to find solutions or to check for consistency. In this case, have these investors ever passed on credit for good performance to the value factor? I think not.
Over the 22 years that I’ve been managing the fund, I’ll openly admit mistakes, both in terms of shares that I’ve bought, and shares that I should have bought, but I believe that I have learned from these mistakes as stock-picking errors, errors of strategic assessment and errors of portfolio construction. The evolution and improvement of our investment process, I believe, bears testimony to that.
None of us have perfect foresight, the world is a difficult and unpredictable place, but it seems the best way to make progress is to change what is going wrong and keep what is going well. We aim to learn not just from our own mistakes, but those of others as well.
Julian Cane is fund manager of BMO Capital and Income Investment Trust.