“The word value is sorta like the word ‘dog’ -- a beagle looks nothing like a Great Dane but both [are] ‘dogs,”’ he wrote in an email. The products are “all under same umbrella but selection criteria means you can have totally different performance even with similar philosophy.”
Bloomberg LP, parent company of Bloomberg News, provides models to track factor returns.
And these days, nowhere are incongruities more striking than in value. Popularized by Graham and Warren Buffett, the principles of value investing -- which aim to identify stocks that are trading for less than their intrinsic value -- are perhaps the most time-tested and academically robust of any model.
Yet since the global financial crisis, how value should be defined has drawn increasing scrutiny -- and criticism. Unsurprisingly, much of the debate has centered on widely followed indexes that have persistently underperformed. Based on indexes compiled by MSCI, cheap stocks in the developed world last month plunged to the lowest versus growth shares since 2000. Over the last decade, they are behind by 43 percentage points.
To some, it’s been a cause for soul searching.
One argument gaining currency is that in today’s knowledge-based economy, traditional ways to determine whether a stock is cheap or expensive are obsolete and no longer apply. Compounding the problem is lower post-crisis growth levels, which have undermined economically sensitive value shares and left investors to crowd into tech darlings like Netflix and Amazon.com.
Olivia Engel, chief investment officer of active quantitative equities at State Street Global Advisors, sees book value as a culprit.
A pillar of the Fama-French model and a Ben Graham favorite, book value simply looks at a company’s assets minus its liabilities. Investors compare that number with its market value to determine whether a stock is cheap.
But these days, intangible assets -- like patents, brand value and proprietary technologies -- have become more important to businesses, something that book value doesn’t capture. That’s because in the U.S., intangibles are mostly expensed rather than capitalized, meaning that they don’t show up as assets. (Intangibles acquired in mergers are the exception.)
McDonald’s, for example, has a negative book value, but it’s hard to believe the world-famous fast-food giant’s assets can’t cover all its liabilities. Biotechnology company Acadia Pharmaceuticals, which spent nearly $150 million on research and development last year, has but $5.5 million of intangibles from a licensing agreement. Yet price-to-book ratio is used to determine inclusion into major value indexes like the Russell, MSCI and S&P Global.
“What you might think is highly unattractive from a valuation standpoint is maybe only mildly unattractive from a valuation standpoint when you start to look at R&D expensing,” said Engel, whose firm incorporates intangibles into its equity models.
Invesco’s Thorsten Paarmann prefers price-to-cash flows. He says it’s the most predictive, and an “honest” metric that’s less prone to accounting shenanigans. Meanwhile, Eaton Vance’s Perkin says enterprise value is better than market capitalization alone because the former accounts for debt. (This might explain the Deutsche Bank basket’s outperformance, which picks stocks by comparing cash flow to enterprise value.)
Michael Hunstad, Northern Trust Asset Management’s director of quantitative research, points to another shortcoming: some industries are always more expensive than others, which means too many value models end up disproportionately skewed toward certain sectors, like financials or energy.