WEBVTT - At the Money: Stock Picking vs. Value Investing

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<v Speaker 1>How much you pay for your stocks has a giant

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<v Speaker 1>impact on how well they perform. Chase a hot etf

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<v Speaker 1>for mutual fund that's run up and you might come

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<v Speaker 1>to regret it. I'm Barry Ridolfs, and on today's edition

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<v Speaker 1>of At the Money, we're going to discuss whether value

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<v Speaker 1>investing should be part of your strategy. To help us

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<v Speaker 1>unpack all of this and what it means for your portfolio,

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<v Speaker 1>let's bring in Jeremy Schwartz, global chief investment officer at

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<v Speaker 1>Wisdom Tree Asset Management and longtime collaborator with Wharton professor

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<v Speaker 1>Jeremy Siegel. Both Jeremies are co authors of the investing

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<v Speaker 1>Classic Stocks for the Long Run. Let's start with a

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<v Speaker 1>simple question, what is value investing?

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<v Speaker 2>Value investing we define as really looking at price versus

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<v Speaker 2>some fundamental metric of value. Are our favorite ones are

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<v Speaker 2>dividings and earnings. You say, why do you buy a

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<v Speaker 2>stock present value of future cash flows? Any asset is

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<v Speaker 2>present value future cashlows, and stocks those cash flows are dividends.

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<v Speaker 2>Dividends come from earnings, and so those are sort of

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<v Speaker 2>anchors to valuation, and you know, so it's a critical

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<v Speaker 2>component judging his stock based on what it produces to

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<v Speaker 2>you as an investor.

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<v Speaker 1>So last time we had you on, we discussed stocks

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<v Speaker 1>for the long term. What advantages do you get from

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<v Speaker 1>investing with a value tails over the long term.

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<v Speaker 2>You know, I think one of the big risks to

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<v Speaker 2>the market are these major bubbles. It sort of tech

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<v Speaker 2>bubble in two thousand is the classic example. And you know,

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<v Speaker 2>Siegel had long been just a Vanguard buy and hold

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<v Speaker 2>in stocks are long when he gave Vanguard a lot

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<v Speaker 2>of free publicity just saying buy the market, buy cheaply

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<v Speaker 2>with index funds until the tech bubble where he started

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<v Speaker 2>talking about this massive overvaluation in sort of these big

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<v Speaker 2>cat tech stocks.

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<v Speaker 1>He had a very famous Wall Street journal piece in

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<v Speaker 1>like large fourteen two thousand so days before the bubble popped.

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<v Speaker 2>And basically said, there's huge tech stocks, triple digitpeasy. You

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<v Speaker 2>can never justify the valuations no matter what the growth.

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<v Speaker 2>So his own portfolio started selling the S and P

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<v Speaker 2>five hundred and buying value. And his second book, The

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<v Speaker 2>Future for Investors, was all about these strategies to protect

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<v Speaker 2>from bubbles and be a valuation sensitive investor, and that's

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<v Speaker 2>where he focused a lot on dividends. A lot on

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<v Speaker 2>earnings and strategies that sort of the market buy those

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<v Speaker 2>factors to try to find the cheapest stocks on those factors.

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<v Speaker 1>So Professor Siegel very specifically said, don't focus on the

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<v Speaker 1>short term price movements. Instead, focus on the underlying fundamentals

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<v Speaker 1>of the business.

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<v Speaker 2>Yeah, And we tell a story in the Book of

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<v Speaker 2>Future for investors, and even now in the new stocks

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<v Speaker 2>are long run of IBM versus Xon, and they are

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<v Speaker 2>two very interesting stories beause they've been around for decades.

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<v Speaker 2>So we look back seventy years of returns, and you

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<v Speaker 2>look at the growth rates of IBM versus x ON

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<v Speaker 2>over the last seventy years, and you say IBM beat

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<v Speaker 2>Xon by three percentage points ZRE on sales growth, three

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<v Speaker 2>percent on earning growth, dividend growth, book value. With any

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<v Speaker 2>growth metric, it wins over all long term time periods.

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<v Speaker 2>But then why was Xon the better return for the

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<v Speaker 2>last seventy years? And it's interesting like Exon sold at

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<v Speaker 2>a twelve pe, IBM sold at a twenty two pe

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<v Speaker 2>on average, one sold at a two percent diven yield,

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<v Speaker 2>one sold at a five percent of yield. Right, so

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<v Speaker 2>you had Exon being the classic value stock IBM the

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<v Speaker 2>classic growth stock. I think of that largely like the

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<v Speaker 2>market versus high dividend or value investing to stay, the

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<v Speaker 2>s and P is around twenty times like IBM was,

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<v Speaker 2>it's below a two percent yield. High dimmerent stocks are

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<v Speaker 2>like a five percent yield and ten pes. So it's

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<v Speaker 2>really this sort of valuation sensitive approach. But people get

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<v Speaker 2>too optimistic on the more expensive parts and two pessimistic

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<v Speaker 2>on the value segments.

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<v Speaker 1>So how should we measure value as an investor, whether

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<v Speaker 1>it's picking out individual stocks or buying broad indexes, what's

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<v Speaker 1>the best way to think about value?

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<v Speaker 2>I mean the real risk to value? Are you buying

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<v Speaker 2>these value traps where the price is low for good reason? Right,

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<v Speaker 2>they're forecasting that fundamentals aren't sustainable, and you never know

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<v Speaker 2>that with a single stock. And so that is we

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<v Speaker 2>talked about diversification and buying index funds for the whole

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<v Speaker 2>market is a very sensible way to do it. Even

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<v Speaker 2>for these value strategies, you can get rules based discipline

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<v Speaker 2>strategies of hundreds of stocks that get you that type

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<v Speaker 2>of value discipline. Whether you're looking at things like high

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<v Speaker 2>divins that we do at with some tree, other factors

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<v Speaker 2>that you can sort by ideas getting a broad doors

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<v Speaker 2>fire portfolio, not trying to buy a single cheap stock.

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<v Speaker 1>So for people who are trying to wrap their head

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<v Speaker 1>around the typical value investor, give us some examples of

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<v Speaker 1>famous value fund managers who put this into practice.

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<v Speaker 2>It was interesting when we first I talked about the

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<v Speaker 2>future for investors and we started working on that, Siegel

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<v Speaker 2>suggested I go read everything Wren Buffett had ever and

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<v Speaker 2>the time Buffett was coming out against the tech stocks too,

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<v Speaker 2>back twenty years ago and saying these.

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<v Speaker 1>I recall people saying, oh, this guy's past his prime.

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<v Speaker 1>He's done. You could put a fork and.

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<v Speaker 2>War on Buffett exactly. And so we were reading every

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<v Speaker 2>letter he had written. And you know, it's interesting. Buffett's

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<v Speaker 2>own evol been from being a Ben Graham style buying

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<v Speaker 2>just cheap price to bookstocks. What he called cigar butt

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<v Speaker 2>investing later on is getting last puffs of these cigars

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<v Speaker 2>that were through cheap stocks at their very last moments,

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<v Speaker 2>towards actually morpheing towards a quality investor and buying Apples,

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<v Speaker 2>one of his flagship companies now. And I do think

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<v Speaker 2>over time they've found buying these high quality businesses at

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<v Speaker 2>fair prices is also part of the value investing framework.

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<v Speaker 2>But he's definitely one that we looked up to and

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<v Speaker 2>tried to model a lot of our thinking of what

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<v Speaker 2>is value investing off of this high quality franchise businesses too,

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<v Speaker 2>you could.

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<v Speaker 1>Do worse than were on Buffett and I recall when

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<v Speaker 1>he was first buying Apple, it was trading at a

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<v Speaker 1>pee of like twelve or thirteen, very reasonable for what

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<v Speaker 1>the company later became.

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<v Speaker 2>Yeah, now it's around thirty times, not having the same

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<v Speaker 2>growth rates as that used to, but it still has

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<v Speaker 2>these huge valuable franchises and they consistently grow their dimons.

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<v Speaker 2>They do buybacks, they're doing the types of returning cash

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<v Speaker 2>or shareholders approach that he likes.

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<v Speaker 1>So we're recording this towards the end of twenty twenty three.

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<v Speaker 1>Both has done really well. What makes value more attractive?

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<v Speaker 1>Then let's call it growth investor.

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<v Speaker 2>You know what we talk about the long term benefits

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<v Speaker 2>to value, But the last fifteen years have been a

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<v Speaker 2>very painful stretch to be a value investor. It has

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<v Speaker 2>definitely been a fifteen year stretch hallmarked by growth until

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<v Speaker 2>twenty twenty two, and then you had things like the

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<v Speaker 2>Nasdaq down a third and high divins stocks positive. Okay,

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<v Speaker 2>now it's reverse again entirely this year in twenty twenty three.

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<v Speaker 2>Going forward, you know what's driven growth? Things like Apple

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<v Speaker 2>that you said, were you know, twelve pees. Microsoft, they

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<v Speaker 2>they had very low pees and then they had above

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<v Speaker 2>average growth and expanding multiple. So we had two tailwinds,

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<v Speaker 2>better growth, multiple expansion. It's going to be hard for

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<v Speaker 2>them to have the same multiple expansion ahead. And so

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<v Speaker 2>then the question all comes down to earnings growth. Can

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<v Speaker 2>these big tech stocks keep growing earnings much faster than

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<v Speaker 2>the market, That's the real question. And they're very big,

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<v Speaker 2>you know, some of them. We'll be able to keep

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<v Speaker 2>their motes for some time. But often when you get

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<v Speaker 2>these high multiples, earnings start to disappoint, and that's when

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<v Speaker 2>the corrections come and value, you know, a high dive

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<v Speaker 2>in basket a ten pe a ten percent earning yield,

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<v Speaker 2>you don't need real growth, you're just getting the return.

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<v Speaker 2>Ten percent is a very good return in real cash flows.

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<v Speaker 2>And so I think that is a basket that I

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<v Speaker 2>think I'm very optimistic on over the next ten years.

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<v Speaker 1>So I hate when people blame bad performance on the Fed.

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<v Speaker 1>But I can't help but wonder fifteen years of outperformance

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<v Speaker 1>by growth investors coincided with very very low rates. Suddenly

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<v Speaker 1>the FED normalizes rates. Maybe it was a little quickly,

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<v Speaker 1>but rates are back up to over five percent. Seems

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<v Speaker 1>to be a period where value does better when capital

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<v Speaker 1>isn't free at any truth to that.

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<v Speaker 2>It's very interesting, and there's there's some debates back and

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<v Speaker 2>forth at cliff Astness saying that interest rates haven't been

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<v Speaker 2>a factor for value as a cycle. Professor Siegel's talked

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<v Speaker 2>a lot about the duration with these high expensive gross

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<v Speaker 2>stocks are being more like long duration assets, and that

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<v Speaker 2>raising rates should impact the valuations of the highest gross stocks.

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<v Speaker 2>It's fascinating. A lot of the traditional relationships are flipped

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<v Speaker 2>on their head. I thought of small caps as benefiting

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<v Speaker 2>from a stronger economy, and you see rising rates good

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<v Speaker 2>for small caps. But small caps today are trading the

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<v Speaker 2>opposite of rates, where they have the most lending that's

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<v Speaker 2>tied to floating rate instruments. They don't have debt, so

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<v Speaker 2>they're barring from banks and using bank loans, so they're

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<v Speaker 2>facing they're like the only people facing the cost of

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<v Speaker 2>these higher rates is they're paying more interest on their

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<v Speaker 2>bank loans, and so when rays have been falling over

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<v Speaker 2>the last few weeks, small caps have been out performing

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<v Speaker 2>or doing much better. So a lot of the traditional

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<v Speaker 2>relationships have been challenged this year. But I think we

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<v Speaker 2>come back to valuation drive's return over the very long run.

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<v Speaker 2>So when we think about small caps and ten to

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<v Speaker 2>eleven pees, high differnes stocks at ten to eleven pees

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<v Speaker 2>that we think will really matter over the long termine,

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<v Speaker 2>not just the FED in the interest rates situation.

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<v Speaker 1>So let's talk exactly about that basket of stocks with

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<v Speaker 1>a ten pe versus a growth basket with a thirty pe.

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<v Speaker 1>I like the idea of a pretty fat dividend yield

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<v Speaker 1>and that low pe. Sometimes in the past we've seen

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<v Speaker 1>high divinend stocks have their yields cut. What sort of

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<v Speaker 1>risk factor we we're looking at with these low pe

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<v Speaker 1>high divnend stocks.

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<v Speaker 2>Yeah, it's absolutely true. You know, a thirty p was

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<v Speaker 2>just a three percent earning shield. Those companies are expected

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<v Speaker 2>and will grow their earnings faster than the high dimon stocks.

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<v Speaker 2>There's no question they're gonna have faster growth rates. Questions,

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<v Speaker 2>can they maintain the growth rates that the markets really

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<v Speaker 2>do expect and so that that's where there's the higher

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<v Speaker 2>the pe, the more the expectation, the harder they fall

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<v Speaker 2>when they disappoint over time. But there is this value

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<v Speaker 2>trapped sense, you know, are you buying just stocks that

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<v Speaker 2>may cut the dividends. We try to screen for things

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<v Speaker 2>that could have sustainable divining growth and negative momentum. Is

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<v Speaker 2>does a market know something that the fundamentals haven't reflected,

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<v Speaker 2>is not in the earnings, non the dibvons yet, So

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<v Speaker 2>you try to screen for that. But in general, what

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<v Speaker 2>we found is a very long period of time, the

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<v Speaker 2>market overly discounts the bad news and sort of they

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<v Speaker 2>become too cheap over a long period of time.

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<v Speaker 1>So what you're really driving towards is expectations matter a lot.

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<v Speaker 1>High pe stocks, high growth stocks have very high expectations

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<v Speaker 1>and they can disappoint just by growing fast but not

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<v Speaker 1>fast enough. And yet we look at these value stocks

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<v Speaker 1>that are often overlooked and they have very low expectations.

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<v Speaker 2>Yeah, I think that's the classic case for like Navidia today,

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<v Speaker 2>which is one of the highest multiple stocks in the SNP.

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<v Speaker 2>They've been delivering, they've been one of the best growth

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<v Speaker 2>stories you've ever heard, you know, continuing the AI revolution,

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<v Speaker 2>But can they keep delivering this record growth rates? It

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<v Speaker 2>can be tough for them.

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<v Speaker 1>We sold the last quarter they had great numbers, not great.

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<v Speaker 2>Enough, and yes they haven't quite broken this new all

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<v Speaker 2>time high level. It's a classic case of it's just

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<v Speaker 2>going to be tough for them to keep delivering on

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<v Speaker 2>these very elevated growth rates.

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<v Speaker 1>So if an investor is thinking about managing risk and

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<v Speaker 1>having a margin of safety, you're obviously saying value is

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<v Speaker 1>the better bet thing.

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<v Speaker 2>Growth value in small caps today both you can get

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<v Speaker 2>ten to twelve times earnings. Yeah, high diffen stocks I

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<v Speaker 2>think are one of the cheaper segments of even within

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<v Speaker 2>the value portfolios. High difms have been especially cheap today.

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<v Speaker 1>So we've been talking about risk, we've been talking about volatility,

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<v Speaker 1>we haven't talked about performance. What are if any, the

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<v Speaker 1>value advantages over the long term regarding performance?

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<v Speaker 2>We found we've done some studies back to the S

0:11:38.080 --> 0:11:41.120
<v Speaker 2>and P five hundred exception in nineteen fifty seven. When

0:11:41.160 --> 0:11:43.720
<v Speaker 2>we look back over that, you know, sixty ish years,

0:11:44.320 --> 0:11:46.959
<v Speaker 2>the most expensive stocks lag the market by one hundred

0:11:46.960 --> 0:11:49.760
<v Speaker 2>to two hundred basis points a year. The cheapest stocks

0:11:49.800 --> 0:11:52.400
<v Speaker 2>outperformed by two hundred bases points a year, and so

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<v Speaker 2>these are compounding over sixty not quite seventy years, but

0:11:56.320 --> 0:11:58.640
<v Speaker 2>very long term periods, and so that there is a

0:11:58.960 --> 0:12:02.040
<v Speaker 2>substantial wealthy caa hmulation that comes with a one to

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<v Speaker 2>two percent year advantage or a lag.

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<v Speaker 1>So to wrap up, investors who concentrate more in value

0:12:10.360 --> 0:12:14.240
<v Speaker 1>indexes tend to have less volatility and lower risk than

0:12:14.320 --> 0:12:19.040
<v Speaker 1>stockpickers and other investors do. And long term value investors

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<v Speaker 1>also have the potential to generate better returns. I'm Barry

0:12:26.040 --> 0:12:31.719
<v Speaker 1>Retults you're listening to At the Money on Bloomberg Radio.