Capitalism Won’t Thrive on Value Investing Alone
Investors fall into two camps: value investors, who base decisions on a careful analysis of revenues and costs, looking for steady performance, and growth investors, who place bets on risky projects with very high potential payoffs. A capitalist economy needs both kinds — those willing to back transformational ventures as well as those who reward prudence and thrift.
A month ago, Charles de Vaulx, a prominent financier fell to his death from his 10th floor New York office, an apparent suicide. Unlike brokers who had jumped in the 1930s Crash, de Vaulx, a resolute value investor, had shunned debt, keeping as much as 40% of funds in cash when he couldn’t find attractive investments.
Rather, de Vaulx had struggled as investors ran to racier alternatives. The assets managed by his International Value Investors (IVA) had dwindled from a peak of about $20 billion to about $2 billion. A week earlier, IVA had liquidated its U.S. mutual funds. Colleagues said it wasn’t about the money – de Vaulx felt had had “failed in his mission of value investing and lost his raison d’etre” although he was personally worth hundreds of millions of dollars.
Other value managers, on the wrong side of exuberant financial markets for more than a decade, have also suffered anguish along with lost clients. They had long taken pride in acting on Franklin’s maxim of doing well by doing good: Buying when others were afraid and stepping aside when prices were on a tear, restrained market excesses and protected their weaker-willed investors from unwarranted fears and hopes.
This is now all in doubt. Loyal clients who stuck with value managers have seen their wealth and the purchasing power of their assets fall far behind.
Value managers can plausibly blame the Federal Reserve for distorting financial markets. But they also long relied on deviations from fair prices as the foundation of their added value. Worse yet, messianic crypto coins seem, for now, to provide safer havens against monetary debasement than the gold purchases that many traditional value investors favor.
Growth investors can also now claim the moral high ground. Their favored digital disrupters have transformed economies — and supported remote work in pandemic lockdowns. Moderna, which developed a Covid-19 vaccine in record time, had never before sold an FDA approved product or earned a profit. Investors who believed in its potential kept the biotech alive for 10 years. Value managers meanwhile stick by aged industries such as oil and delight in finding cigar butts, good for just a puff or two but can be bought for next to nothing.
The two camps have profoundly different views about history. Value investors share Ecclesiastes’s conviction: “What has been will be again, what has been done will be done again;…there is nothing new under the sun.” They buy when their favored multiples — of profits, assets, cash-flows, rents per square foot, or whatever — are historically low and sell when the multiples are high. This world view in turn encourages investments in stable franchises managed by conservative executives who won’t deviate from the tried and true.
For forward-looking growth enthusiasts, “history is bunk,” as Henry Ford put it. Like the robotics pioneer (and founder of Fujitsu Fanuc) Seiuemon Inaba, they believe that for technological innovators, “the past doesn’t exist. There is only creativity, always looking to what is next.” In this domain, comparisons to past valuations and multiples mean little and the eccentricity and unpredictability of visionaries like Tesla’s Elon Musk are hardly disqualifications.
Although I have studied innovative ventures and eccentric founders for more than 30 years, I cannot shed my skepticism of too-popular growth stories. My personal investments, perhaps reflecting hairshirted stubbornness, have continued to favor out-of-favor assets. My teaching and writing likewise celebrates bootstrapped ventures like Hewlett-Packard and Microsoft that did not make big bets with other people’s funds. Yet I recognize that audacious, possibly overconfident, investors made crucial contributions to fabled companies like Federal Express and Google — as well as to nearly all the bio-techs now revolutionizing medicine.
A year ago, I joined the board of the incongruously named Scottish Mortgage Investment Trust, managed from Edinburgh but dedicated to global growth investing. Its early investments in the likes of Tesla, Amazon, and Alibaba have produced, as of April, a more than 1,900% return in the last 20 years — about four times higher than Warren Buffett’s value based returns. The Trust’s managers charge low fees and, like Buffett, are loath to take quick profits. For instance, the Trust started heavy buying of Tesla shares in 2013 when they traded at $6 a share and did not sell any shares till this January when holdings in the carmaker had reached nearly 9% of the Trust’s portfolio (and Tesla was trading at about $800 a share).
The Trust’s approach reflects a conviction that valuations of seemingly richly priced growth stocks may under-estimate the long-term potential of the underlying businesses and technologies. For instance, even after a five-fold rise in the last 12 months, Moderna’s stock may be cheap compared to the eventual value of its mRna capabilities. But even with careful research and great acuity, investors cannot reliably distinguish underappreciated gems from the duds. Buying tomorrow’s Teslas — and hanging on through stomach churning fluctuations — therefore requires an intestinal fortitude at least comparable to investing in out-of-favor stocks. For the growth investor there is no margin of safety and no comfort from cheap historical valuations.
Of course, growth will not forever trounce value. Inevitably, when the world writes off value, it will roar back. This may have already started but who knows how far it will go or for how long the value revival will last? Regardless of personal tastes therefore, investing in both value and growth, possibly through index funds, is always wise.
The dynamism of our economy also requires both sensibilities. In Max Weber’s classic formulation, thrift is the bedrock of capitalism while Deidre McCloskey includes bourgeois prudence. And thrifty prudence which disdains, this time it’s different rationalization, promotes the efficient exploitation of existing resources, releasing more capital for more investments. But capitalist economies would not survive just by investing in more of the same. Their adaptability, technological progress, and appeal to the human love for adventure, requires innovators whose dreams defy objective calculation of the risks and returns and investors with the guts to back them.