Viewed through the lens of today’s negative real interest rates, it provides a mathematical justification for the greater fool theory. “When the discount rate is lower than the growth rate, the stock price theoretically has infinite value,” he says. The flip side is that these conditions make it virtually incoherent to try to calculate the real value of a growth stock. Add to this mix the behavioral impact of a pandemic, both financially and societally, and pricey, work-from-home stocks suddenly are seen as defensive plays in a winner-take-all world.
Multiple expansion may be the most obvious explanation for the sustained underperformance of value, but it’s not the only one. Markets reflect a changing set of metrics.
In their August paper, Arnott and his colleagues note that as far back as 1934 Graham and Dodd “cautioned” against overreliance on book value-to-price as a substitute for intrinsic value. In an interview in the August 2017 issue of Financial Advisor, GMO founder Jeremy Grantham said book value, the stated value of assets and liabilities on a company’s balance sheet, has morphed into a measure of which companies have the “dopiest” assets.
Companies’ intangible assets, including patents, software, brand and human capital, among others, are often at the core of a company’s “ability to generate and maintain profits,” and are often totally ignored by their book value. The Research Affiliates authors devise several ways to address the mismeasurement of value, including the capitalization of increasingly important intangible assets, but conclude it is inferior to simpler, traditional yardsticks like sales-to-price and earnings-to-price.
In the end, the authors conclude there is no definitive reason to assume that value investing is structurally impaired, even if certain companies and industries are facing secular challenges. If mean reversion is not just a concept but a law of finance, future relative returns for value should be attainable.
Exactly how that mean reversion unfolds remains to be determined. Does anyone recall the event that triggered the puncturing of the dot-com bubble?
There wasn’t one. Tech stocks like Cisco simply ran out of suckers to buy them. Wile E. Coyote managed to momentarily stay airborne after jumping over a valley. But at some point he looked down and noticed there was no ground under him anymore.
It’s quite possible that the growth-value performance gap could narrow thanks to a swoon in growth stocks, not from any surge in value.