Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe Wisenthal. So, Joe, when
Speaker 1: you think about value investing, what what springs to mind? Um?
Speaker 1: I guess probably immediately the image of Warren Buffett floats
Speaker 1: into my head as soon as I hear that term,
Speaker 1: or maybe that big um Benjamin Graham book that I
Speaker 1: bought when I was like early on in my career
Speaker 1: and never read. But it's like one of the most
Speaker 1: famous investing books about how to invest, like how they
Speaker 1: did back when they bought like bonds from Brooklyn Railways
Speaker 1: and stuff like that. At least you're honest about it.
Speaker 1: But I think for most people, it's definitely that image
Speaker 1: of Warren Buffett and someone sort of seeking out these
Speaker 1: undervalued stocks in the market that are going to generate
Speaker 1: longer term gains and making loads of money from it.
Speaker 1: That's sort of the classic value investing paradigm. Yeah, And
Speaker 1: I think like when I first became aware of how
Speaker 1: the world of investing worked, I sort of thought that
Speaker 1: was essentially the essence of it, that you're supposed to
Speaker 1: find cheap stocks and look at the stocks that had
Speaker 1: low pe ratios and low price to book ratios and
Speaker 1: if there was a good one that had some nice
Speaker 1: low ratios, then those were the stocks to buy. And
Speaker 1: that's basically what investing is. And I know there are
Speaker 1: a lot of people who are still adherance of that approach,
Speaker 1: but over the years, I've learned that there's sort of
Speaker 1: multiple approaches to doing well in the stock market. Yes, indeed,
Speaker 1: and the big headwind I would say for value investing
Speaker 1: over the past uh, well, it's been more than a
Speaker 1: decade actually, but basically since the start of the financial
Speaker 1: crisis sort of two thousand seven, value investing has massively,
Speaker 1: massively underperformed a lot of other investing styles. And this
Speaker 1: means that a bunch of people have been watching their
Speaker 1: heads trying to figure out exactly why this is happening. Yeah,
Speaker 1: there's a lot of consternation among people for whom they
Speaker 1: look at the data. And historically it says if you
Speaker 1: buy lots of companies, a basket of companies with the
Speaker 1: low price to book ratio or low PE ratio, they
Speaker 1: should eventually outperform um. But they haven't. And that's sort
Speaker 1: of been one of the main stories post crisis, is
Speaker 1: this persistent underperformance of the so called value factor, and
Speaker 1: people keep trying to call the turn. They now the
Speaker 1: fetters raising race. Okay, the value factors gonna perform. Oh,
Speaker 1: we're going into a bit of a downturn. This is
Speaker 1: the moment. And it keeps eluding the adherence of this view,
Speaker 1: and you have some people saying value is dead or
Speaker 1: this style is never going to work again. But of
Speaker 1: course you have people holding out that eventually this approach
Speaker 1: will come back and vogue. Yeah, exactly, and you sort
Speaker 1: of alluded to it just then. But there are all
Speaker 1: these theories about why exactly value has been underperforming. The
Speaker 1: big one, of course, is central banks and low interest rates.
Speaker 1: But one explanation, uh that doesn't get as much attention
Speaker 1: has to do with technology. And this is a really
Speaker 1: interesting one I think. Um, you know, some analysts have
Speaker 1: talked about it a bit before, but the notion that
Speaker 1: big technological discoveries or turns can basically lead to under
Speaker 1: performance and value is one that I think is worth exploring,
Speaker 1: right And you know, it's interesting because obviously, I think
Speaker 1: a lot of people know that the best stocks of
Speaker 1: the last several years have been this these high flying
Speaker 1: tech stocks like Amazon or Facebook or whatever, Netflix, which
Speaker 1: are nobody's idea. Very few people would characterize them as
Speaker 1: value stocks, at least under the traditional notion. But I guess, uh,
Speaker 1: and we're going to talk about this on today's episode,
Speaker 1: that this isn't that rare, that there are these periods
Speaker 1: of times when there can be a companies on the
Speaker 1: vanguard of a new technology, trading at extraordinary multiples, outperforming value,
Speaker 1: but it doesn't last forever. This isn't the first time,
Speaker 1: I guess that we've seen companies like Amazon and Netflix
Speaker 1: help expensive stocks be the big winners. Yeah, exactly, So
Speaker 1: I guess, without further ado, I should bring on the
Speaker 1: guest for the episode. It is Chris Meredith. He's co
Speaker 1: c I O over at O'Shaughnessy Asset Management and also
Speaker 1: a visiting lecture at Cornell University. Chris, thanks so much
Speaker 1: for coming on. Thank you for having me. So I
Speaker 1: should just mention the reason we're having you on is
Speaker 1: actually a suggestion from your your co researcher on a
Speaker 1: recent paper, Mr Jamie Catherwood, who was of course a
Speaker 1: previous odd lots guests. Lots of people will know him
Speaker 1: as the finance history guy. He helped you look into
Speaker 1: whether or not there are historic parallels for under performance
Speaker 1: in value investing. Just to step back initially, can I
Speaker 1: ask why you decided to to go on the hunt
Speaker 1: for those historic parallels. Well, obviously it's borne out of
Speaker 1: what you were talking about earlier, where value has underperformed.
Speaker 1: Value is one of the bedrock principles at O'shaughnessysset Management.
Speaker 1: And obviously it's been a difficult, you know, time since
Speaker 1: the beginning of two thousand seven. To set it in context,
Speaker 1: some of the style benchmarks that are used in the
Speaker 1: large cap like Russell one thousand, value versus growth over
Speaker 1: that time period from the beginning in two thousand seven
Speaker 1: to the middle of it's a it's a return gap
Speaker 1: of about thirty six percent, which is a tremendous difference,
Speaker 1: and over the last twenty four months it's an additional
Speaker 1: So that's obviously where clients, allocators, financial advisors, they're all
Speaker 1: looking to us and trying to understand what's going on.
Speaker 1: Anybody who has a value bias against a core benchmark
Speaker 1: or growth managers that are putting value governors on it,
Speaker 1: they're all feeling this as a long term headwind in
Speaker 1: their investment styles and strategies. And so we started taking
Speaker 1: a look, and what we had seen was there's a
Speaker 1: lot of people in industry that are using data I
Speaker 1: call it like a short form aided dump where they
Speaker 1: just take like the Fama French series and they put
Speaker 1: out there and they're saying, look, this is this is
Speaker 1: the worst it's ever been, so it must be broken, right, UM.
Speaker 1: And there's a lot of people that are just just
Speaker 1: just to back up when they say this is the
Speaker 1: worst that's ever been, they say, this is the worst
Speaker 1: under performance of the value factor relatively the market. And
Speaker 1: you know, a lot of times they're dealing with shorter
Speaker 1: data series than than you know, than we have available
Speaker 1: at O'Shaughnessy because we've invested in a research platform that
Speaker 1: lets us test all the way back to ninety six
Speaker 1: and we've spent you know, millions of dollars and million
Speaker 1: over ten years in order to get this platform and
Speaker 1: allowing us to do research. UH. And one of the
Speaker 1: things that we were looking at was saying, okay, let's
Speaker 1: let's use our platform and try to figure out, you know,
Speaker 1: if we've seen a period like this before. UH. And
Speaker 1: you know, we had built out a research data set
Speaker 1: proprietary to osam O'Shaughnessy that we call Deep History, that
Speaker 1: where we took all the Moody's financial statements and we
Speaker 1: we had to actually team overseas type those up and
Speaker 1: put them into our platform. So we were able to
Speaker 1: look at things like net income and sales, and we
Speaker 1: found that there's another period of value under performance similar
Speaker 1: to this one back in nineteen And what's interesting is,
Speaker 1: you know, you start you start looking at those periods,
Speaker 1: um you know, and I've I've heard people say, you know,
Speaker 1: what would that time period have anything to do with today?
Speaker 1: It's obviously it's incredibly different, um And and there are
Speaker 1: differences obviously, but there's also a ton of similarities. And
Speaker 1: when we started looking at it, obviously with you know
Speaker 1: what we see with recession depression that happened, interest rates
Speaker 1: falling to zero and that time frame, but also that
Speaker 1: the the increase of technological shift of that time frame
Speaker 1: is comparable to today. And what really cemented it and
Speaker 1: and and made it come home was when we we
Speaker 1: started first we started looking at what companies were outperforming
Speaker 1: on the growth side versus the value side, and that
Speaker 1: time frame and you you you nailed it. Where today
Speaker 1: it is technology stocks on the growth side that are
Speaker 1: the fang stocks, let's just you know, sum it up
Speaker 1: that way. And on the on the value side, it's
Speaker 1: financial stocks. Right, those have been having a structural headwind
Speaker 1: obviously since two thousand seven. Financial stocks wind up in
Speaker 1: the value ledger, right, So that's part of the split
Speaker 1: there is technology is doing great. Financi stockstone entally that
Speaker 1: time frame forty one, it was manufacturing stocks that were
Speaker 1: the tech stocks of the day and versus utilities and
Speaker 1: which I include railroads and steam railroads and utilities that
Speaker 1: were essentially the ones dragging. And the interesting part was
Speaker 1: what we found was we were doing research and we
Speaker 1: were reading and there was one book that just that
Speaker 1: just cemented and put it home, and it was Carlotta
Speaker 1: Perez's Technological Revolutions and Financial Capital, where she was talking
Speaker 1: through long term economic waves called that short form, they
Speaker 1: call him technological revolutions, and they've identified five of these.
Speaker 1: Historically they're able to identify because the timing of market
Speaker 1: crashes that come along with them. But mainly, what what
Speaker 1: it summed up was that the stocks that we're winning
Speaker 1: in that time period, Uh can be automobile stocks, so
Speaker 1: you're talking about GM. Ford was a privately list of stock,
Speaker 1: but GM was the big one of the of the
Speaker 1: publicly listed at that time frame. And oil stocks like
Speaker 1: standard Oil, which we're supplying gasoline, and then retail stocks
Speaker 1: like Sears and will Worth in manufacturing and all those
Speaker 1: are bundled together with this id you have clusters of
Speaker 1: technological innovations that changed the socioeconomic paradigm of how people
Speaker 1: deploy their capital. And the way to think of that
Speaker 1: is that, you know, back in the nineteen tens, you know,
Speaker 1: people were getting around by the steam railroad and that
Speaker 1: was how they got around, and then it was like
Speaker 1: bicycles for the rest of it, and they hadn't figured
Speaker 1: out that last mile, right. Henry Ford invented the model
Speaker 1: Tea and in particular this idea of mass manufacturing and
Speaker 1: the idea that then automobiles went from zero to zero
Speaker 1: point eight per household in the US, and all of
Speaker 1: a sudden there was this just massive change of how
Speaker 1: everybody got around the country. Was our c A was
Speaker 1: like another like massive stock market winner, the Radio Company.
Speaker 1: And I sort of like when I've read about the twenties.
Speaker 1: I always see like it always feels like the explosion
Speaker 1: of radio is probably similar to the internet today. Was
Speaker 1: that one of the ones that was sort of in
Speaker 1: the growth factor in those years. Radio is another another
Speaker 1: great example of that and the idea of mass manufacturing
Speaker 1: of radios but entertainment as well. But in particular, what's
Speaker 1: interesting is this idea of mass manufacturing led to things
Speaker 1: like Nibisco National Biscuit back in the day, which started
Speaker 1: mass producing food and sending those out with which led
Speaker 1: to national brands, mass culture, and then advertising, which led
Speaker 1: to the advent of radio and entertainments and medium for
Speaker 1: delivering that as well. So that's again it's part of
Speaker 1: that pocket, that cluster of innovation and which again just
Speaker 1: radically changed how people were basically just spending their money. So,
Speaker 1: Chris Uh, you argue that innovation from technological revolution basically
Speaker 1: changes societal behavior in a bunch of different ways, and
Speaker 1: that impacts business and the economy in a bunch of
Speaker 1: different ways. Could you maybe dig in a little bit
Speaker 1: more into exactly how it impacts value investing, Like, what
Speaker 1: was the shift that we would have seen in the
Speaker 1: time period that you just described. Yeah, so let's let's
Speaker 1: back up and talk about value investing a little bit
Speaker 1: and how the value versus growth stocks and what we've
Speaker 1: seen at O'Shaughnessy with our research. We did a research
Speaker 1: paper about eighteen months agoll Ago called Factors from Scratch,
Speaker 1: where we dug into the mechanics of value investing. And
Speaker 1: the way that it works is that, um you get
Speaker 1: compensated as an investor through a couple of avenues. One
Speaker 1: if you think of it as you buy a stock
Speaker 1: and it's got a a pe of ten. As a
Speaker 1: value investor, it's either going to have it where it
Speaker 1: maintains the same earnings and it and it rerates to
Speaker 1: like a higher multiple of a PEU fifteen, which gives
Speaker 1: you get a fifty percent return, or the earnings are
Speaker 1: going to grow in the multiple stays the same and
Speaker 1: you get you know, you get compensated. That way, we
Speaker 1: dug in and built a framework to analyze growth stocks
Speaker 1: versus value stocks, and what happens is value stocks on
Speaker 1: average actually see some short term call it flatness to
Speaker 1: decline and earnings, but then they re rate over time period, right,
Speaker 1: but there's a stabilization where they they decline a little bit,
Speaker 1: but then come back to normal growth levels, right, and
Speaker 1: growth stocks have it where there's this price for these
Speaker 1: incredible future earnings um that they tend to not reach, right.
Speaker 1: And all this is on average over to long time
Speaker 1: periods across you know, thousands millions of stocks that we've
Speaker 1: been looking at historically over our millions over different time periods.
Speaker 1: Right now, what we see is in these periods where
Speaker 1: growth is outperforming value, what happens is the growth stocks
Speaker 1: actually live up to their potential. If you think about
Speaker 1: Amazon right now, Amazon had ten billion, you're talking about
Speaker 1: it had ten billion in net income. Right ten years ago,
Speaker 1: the company was priced about thirty billion dollars, so it
Speaker 1: had a pe of on a four ten year basis
Speaker 1: of about three. Right, So you're saying, would somebody argue
Speaker 1: Amazon's value stock you could argue on a ten year basis,
Speaker 1: you know, Amazon lived up to its value, right. And
Speaker 1: I remember, like, even which is forever ago, people like, oh,
Speaker 1: this's crazy what people are paying for Amazon. And then
Speaker 1: you look now it's like, not only was that not crazy,
Speaker 1: that was cheap based on what the income did over
Speaker 1: the next several years exactly. And so this is the
Speaker 1: idea that there's these changes in technology which leads to
Speaker 1: accelerated growth of companies that lives up to its potential.
Speaker 1: And that's where these technology companies, the fang stocks have
Speaker 1: have earned their their keep. I mean, this is different
Speaker 1: than the dot com bubble, where there was these incredible
Speaker 1: valuations and then the growth wasn't there, right, So that's
Speaker 1: a different time a different time frame, a different outcome
Speaker 1: on this. This experience of growth in value stocks where
Speaker 1: you've seen you know, financial company is obviously struggling with
Speaker 1: what's happened. They have increased regulation, they're unable to increase
Speaker 1: their their growth over time, and they're not they're not
Speaker 1: stabilizing back to normal growth levels. You have energy stocks
Speaker 1: have seen multiple shocks, Retail that's getting a head wind
Speaker 1: from Amazon. All those stocks are having difficulty and that
Speaker 1: idea of maintaining In fact, they've been getting the same discount.
Speaker 1: What we've seen is those discounts have been priced in
Speaker 1: pretty pretty close to what they should have been right now.
Speaker 1: The comparison from the forty one is this idea that
Speaker 1: automobiles were priced this growth stocks, and those actually did great,
Speaker 1: they grew. It was a part of the everybody everybody
Speaker 1: bought one by the time, So that's the comparison and
Speaker 1: the time framing. On the flip side, railroads were once
Speaker 1: that got I got left out peak railroad and passenger
Speaker 1: travel was back in. And so that's one where on
Speaker 1: the value letter they saw a structural decline for what
Speaker 1: happened in their economic Well, I want to ask you
Speaker 1: a question about the definition of value investing or maybe
Speaker 1: different approaches. And I know, like I follow trend Griffin
Speaker 1: on Twitter. He talks a lot about the distinction between
Speaker 1: value as a sort of satistical factor, which is, you know,
Speaker 1: you look at the thousands of stocks out there, and
Speaker 1: then you take the cheapest ones on various multiples, versus
Speaker 1: value as say approached by Warren Buffett of a concentrated portfolio,
Speaker 1: some of which may be cheap on metrics, but some
Speaker 1: of them maybe not so cheap, but he has other
Speaker 1: things that he likes about them, whether great brands or
Speaker 1: great modes or whatever it is. Okay, is there a
Speaker 1: distinction between those two ways in which people use the
Speaker 1: term value investing? Yes, and and and part of it's
Speaker 1: a simple value, right if you just only go off
Speaker 1: of evaluation multiple, we're seeing more of that nowadays with
Speaker 1: these widespread etf that are single value factor or value models, right,
Speaker 1: and they're just basically saying we're only going to give
Speaker 1: you like that, looking at like you said, broadly, a
Speaker 1: couple of metrics maybe and just saying these are we're
Speaker 1: going to buy you the cheapest part of that versus
Speaker 1: the you know, the more the buffet fundamental model, which
Speaker 1: is they tend to look for quality, like you said,
Speaker 1: the good management economic modes, UM, some form of called
Speaker 1: long term trend for why this company would be a
Speaker 1: good value or essentially you know, we have it where
Speaker 1: you're able to get more qualification on that reason for
Speaker 1: the discount and the reason that I should revert back
Speaker 1: to normal multiples and O shaughnessy, we we tend towards
Speaker 1: that side. We look at multiple characteristics of blending those together,
Speaker 1: things like quality of earnings, things like earnings growth to
Speaker 1: try to determine which stocks are more likely to have
Speaker 1: the rebound you mentioned um sort of e t S.
Speaker 1: And I was curious, you know, I'm I think back
Speaker 1: to say twenty years ago, as someone trying to capture
Speaker 1: the value factor within the stock market, and I imagined
Speaker 1: that like required a lot of legwork and a lot
Speaker 1: of people doing a lot of calculations, and probably a
Speaker 1: lot of the kind of investment you're talking about of
Speaker 1: scrubbing the data and just doing it by hand. Now
Speaker 1: I could go on to anyone can sort of go
Speaker 1: into their brokerage account and click I want to buy
Speaker 1: a value et F and then walk away without doing
Speaker 1: any work. Does that change the game? When value investing?
Speaker 1: It's no longer work to sort of even discover the
Speaker 1: value factor is just click of a button. Someone else
Speaker 1: has done it for you. So it is easier to
Speaker 1: access you know, quote unquote value than it has ever
Speaker 1: been before. And that's because of the product proliferation right
Speaker 1: where you're seeing access of our very low fee funds
Speaker 1: that are coming around and and you know, again like
Speaker 1: you said, they are on many platforms. Are et fs
Speaker 1: are easy to buy from our point of view, though
Speaker 1: ease of access doesn't mean that you're getting better investments
Speaker 1: out of it, right, because there's a wide range of
Speaker 1: outcomes that still comes from any of these investment products.
Speaker 1: The difficulty is communicating the transparency of of what the
Speaker 1: what the features are in each of those products. Right,
Speaker 1: So you know, are you buying on book value? Are
Speaker 1: you buying on earnings? By the way, how are you
Speaker 1: calculating earnings? The example we gave we wrote I wrote
Speaker 1: a paper cult Factors and not Commodities a couple of
Speaker 1: years ago, Um, and you were talking about going in
Speaker 1: and getting the data. There's a lot of nuance. And
Speaker 1: again I say nuance in my world from my seat
Speaker 1: on things like even as simple as a PE ratio,
Speaker 1: where you can have companies that will wind up having
Speaker 1: it where you're depending on if you're accounting for extraordinaries,
Speaker 1: preferred dividends, an occasional tax cut that comes around every
Speaker 1: once in a while boosting earnings, right, And if you
Speaker 1: put that all and you can wind up with some
Speaker 1: wildly different outcomes. Kraft Heins had seven million net income
Speaker 1: and then at seven seven billion and met income plus
Speaker 1: a seven billion dollar boost from the tax cut. Right.
Speaker 1: So if you don't account for that or not, you know,
Speaker 1: you wind up having a PE that's half of what
Speaker 1: it should be along the way. So I have a
Speaker 1: sort of big picture existential question. And part of this
Speaker 1: is because I just got done talking with um John Hampton,
Speaker 1: the hedge fund manager, who is pretty dismissive of value investors,
Speaker 1: and he sometimes refers to them as sort of bearded,
Speaker 1: self righteous people who think they're smarter than everyone else.
Speaker 1: I say, I'm in the studio with with Chris right now.
Speaker 1: He does not have a beer. I shaved my beer
Speaker 1: a couple of months. Okay, okay, very important details. So
Speaker 1: my question is why should value investing generate higher returns
Speaker 1: than say, growth stocks, because isn't that basically saying that
Speaker 1: the market has misvalued the companies or um misvalued their
Speaker 1: potential earnings growth. I guess yes, is the is the
Speaker 1: short answer. What happens is over a normal long term
Speaker 1: market cycle, what we have seen, and this again is
Speaker 1: borne out from data we've looked at, you know, over
Speaker 1: ninety two years of value investing to show that on average,
Speaker 1: what happens again is these companies your biomins these incredible discounts. Yes,
Speaker 1: they come with some distress along the way, some near
Speaker 1: term distress where um you'll possibly see earnings decline over
Speaker 1: twelve months, but they'll re essentially get back to a
Speaker 1: normal earning stream and earnings growth level within three years,
Speaker 1: and the market will discount those at thirty percent when
Speaker 1: they should be discounted fiftcent based on earnings. Right, So
Speaker 1: the idea is, like, what you're getting is that discount
Speaker 1: over a three year basis of close to five percent
Speaker 1: a year on average. Now, there are periods of time
Speaker 1: where that distress gets increased and these companies wind up
Speaker 1: having it where their priced effectively and growth stocks have
Speaker 1: the flip side where you know, on average their priced
Speaker 1: to have this incredible growth of like, but they actually
Speaker 1: only achieve twenty percent, right, or so they lose five
Speaker 1: percent on average over those three years. So that's one
Speaker 1: where again if you look over ninety two years, yes,
Speaker 1: that value investing is one that should bear out over time,
Speaker 1: but what we have seen, particularly when extending it back
Speaker 1: to include periods one, is that there can be extent
Speaker 1: periods of time where this gets in burned. So how
Speaker 1: long should investors actually be willing to wait until they
Speaker 1: are rewarded for their value investing? Because as you mentioned before,
Speaker 1: we're now in sort of the twelve fear of under performance,
Speaker 1: it's fairly unprecedented. How much longer should people be waiting? Well,
Speaker 1: for us, that's that's that's the hardest part, which is
Speaker 1: keeping to a discipline when a strategy is working against you. Right.
Speaker 1: Obviously this has been painful, you know, as us having
Speaker 1: a value bias with our strategies and value strategies overall.
Speaker 1: This is one where you know you want to see
Speaker 1: it revert back in a in a in a quicker fashion.
Speaker 1: But obviously the market is held out and these growth
Speaker 1: these growth stocks have continued to outperform for us. What
Speaker 1: we feel would be the worst thing to do would
Speaker 1: be to abandon our principles at this point, right. And
Speaker 1: the idea is that we see that there are signs
Speaker 1: coming around of us working towards the end of this
Speaker 1: one is his formation of oligopolies, where we're seeing these
Speaker 1: companies that come out the fank stocks winner. If you
Speaker 1: look at the change in leadership since two thousand seven,
Speaker 1: the technology stocks are obviously at the top right now.
Speaker 1: But then there's this also component of call it the
Speaker 1: companies out are the previous regime starting to adopt, where
Speaker 1: you're seeing large companies building out their own data science
Speaker 1: teams um and they're starting to catch up. Right. So
Speaker 1: the art that was like the call it the shifting
Speaker 1: moment from the forty one was dieselization of the railroad industry.
Speaker 1: They basically started and they shifted where before it had
Speaker 1: been steam engines that I didn't realize that it took
Speaker 1: like three people a half a day to start up
Speaker 1: in a railroad like a locomotive instead of turning a
Speaker 1: key and starting up an engine. So when they shifted
Speaker 1: to that, they went from again where trucking had suddenly
Speaker 1: had an economic benefit over railroads to now railroads having
Speaker 1: economic you know, benefit over or trucking. And then it
Speaker 1: started going back where value stocks shot the moon. What
Speaker 1: we expect to see happen is that again the technology
Speaker 1: is is embedded. Things like the mobile computing platform is
Speaker 1: is set and standardized, and you're seeing companies like you know,
Speaker 1: Domino's Pizza, who has been killing it in mobile because
Speaker 1: they've sat there and they were there early adopters, and
Speaker 1: they realized everybody was ordering through the web on their phone,
Speaker 1: so they built an app, and all of a sudden,
Speaker 1: now they're they're they're crushing in a mobile platform. You're
Speaker 1: gonna start seeing more and more of that right where
Speaker 1: traditional companies are going to be me seeing the benefits
Speaker 1: of the technology and those values stoction wide about performing
Speaker 1: didn't Domino didn't they come public the same day Google did? Right?
Speaker 1: Isn't that the deal with them? And they've actually I
Speaker 1: think that they've actually outperformed Google. Didn't know that. Maybe
Speaker 1: that's a great story. May be making that up. I
Speaker 1: think that's true, though. I think you're right, Joe, it's
Speaker 1: a good chart. Yeah, we'll have to we'll have to
Speaker 1: go back to look at that one. We'll have to
Speaker 1: accompany that chart Pizza over Internet search. So just further
Speaker 1: to this point, because Tracy kind of anticipated where I
Speaker 1: was going to go with the question, when you look
Speaker 1: at that ninety one period, what were the things that
Speaker 1: happened at the tail end of that, and explicate further
Speaker 1: on what you see is perhaps the end of the
Speaker 1: dominance of these fangs or growth factor because for several years,
Speaker 1: again disbelief that they could continue to grow like this,
Speaker 1: and right now, you know, it's like everyone's been foolish
Speaker 1: trying to predict the end of Netflix or trying to
Speaker 1: predict the end of how fast Google on Facebook can grow.
Speaker 1: So what are some of the signs you look for
Speaker 1: that that period of underperformance for value while growth actually delivers.
Speaker 1: What if what if the end looked like so For
Speaker 1: for me, part of it was established the establishing the
Speaker 1: form factor for how people are gonna be using this
Speaker 1: new socio economic paradigm. And you know, that's one where
Speaker 1: I think the shift that came around was the introduction
Speaker 1: of the iPhone, which just radically changed how people use
Speaker 1: mobile devices. So if you think about it, the way
Speaker 1: I think about what's going on right now is that
Speaker 1: there's this technology and it started off with desktop computing
Speaker 1: in the Internet. Amazon gotten into that and they established
Speaker 1: the trust in that form factor of being able to
Speaker 1: have commerce over with somebody a third party basically over
Speaker 1: the Internet, and have that be a trusted transaction. Uh.
Speaker 1: The iPhone, he basically shifted that all around. And because
Speaker 1: if you think about the adoption curve of that and
Speaker 1: to move people off of the desktop to mobile and
Speaker 1: to the tablet introducing that as well, and that adoption
Speaker 1: rate's hard to bleep. But in there was only people
Speaker 1: with a smartphone, and now it's a of the country
Speaker 1: and you know, I think something like sevent or under
Speaker 1: the age of fourteen, So I tells you like pretty
Speaker 1: much every adult has has a phone right at this
Speaker 1: point has a smart phone, and they're and they're starting
Speaker 1: to use it. So that part where and then iPhone
Speaker 1: sales basically peeked out last year, right, So there's there's
Speaker 1: part where there's this adoption of the standard that's going on,
Speaker 1: and then comes the utilization of it. So in Carlotta
Speaker 1: Perez's framework, there's a installation phase and the deployment phase,
Speaker 1: and the installation phase is all about setting the standards,
Speaker 1: seeing the mass adoption, and then comes the after effect
Speaker 1: to the golden age she calls it, where it's all
Speaker 1: the people utilizing that, and that's where we've seen traditional
Speaker 1: value investing come around. So the signs of this are
Speaker 1: a part of it are, you know, seeing the peak
Speaker 1: on the iPhone, seeing where that form in factor is set,
Speaker 1: and then seeing other companies adopt that platform and being
Speaker 1: able to use that broadly to extend their economic models.
Speaker 1: So when the world is going through a period of
Speaker 1: disruptive new technologies, such as the rollout of the iPhone,
Speaker 1: how do you start differentiating winners and losers among value stocks?
Speaker 1: Because you actually point out in your paper that, for instance,
Speaker 1: BlackBerry at one point basically looked like a value stock
Speaker 1: before being absolutely crushed by various pressures. So how do
Speaker 1: you avoid investing in something like a BlackBerry at precisely
Speaker 1: the wrong moment. This goes back to your point earlier
Speaker 1: about you know, just pure ratios versus having quality themes
Speaker 1: that go along with it in other ways to look
Speaker 1: and again that's where at O'Shaughnessy. What we do is
Speaker 1: it maybe quantitative, but we look across the entire business.
Speaker 1: So part of that is looking at the balance sheet,
Speaker 1: looking at the leveraging side of it, looking at the
Speaker 1: quality of the earnings, which is are they coming from
Speaker 1: cash flows, are they coming from things like you know,
Speaker 1: manipulation of inventoria or depreciation uh, as well as looking
Speaker 1: historical growth of the company, the momentum of the company.
Speaker 1: All these are signals that you blend together, and when
Speaker 1: you do that, you can build a quantitative profile of
Speaker 1: companies that are called value traps versus versus UH. You know,
Speaker 1: growth stocks are value winners, let's call it. I think
Speaker 1: we did a follow up paper two factors from scratch
Speaker 1: called alpha within factors that talked about the difference of
Speaker 1: these and how you're able to use these other characteristics
Speaker 1: to try to forecast future earnings within value companies. So
Speaker 1: in the case of BlackBerry explicitly it would have come
Speaker 1: with terrible negative earnings earnings growth as well as terrible momentum.
Speaker 1: And those were the reasons that I have screened out
Speaker 1: of our process when it was coming through on the
Speaker 1: earnings decline. So is it more about eliminating the losers
Speaker 1: than picking the winners? I would say it's it's on
Speaker 1: both sides of that. But we in our process, we
Speaker 1: have a part where we set the universe. There's an
Speaker 1: explicit part where we rip out companies we think are
Speaker 1: going to underperformed. So, yeah, the losers, those get the
Speaker 1: first swipe of saying these are these have some really
Speaker 1: terrible characteristics. Let's just get rid of those, which is
Speaker 1: one of the benefits I think of an active process
Speaker 1: over over a passive. So let's say we're coming to
Speaker 1: an end, or maybe in a couple of years, we're
Speaker 1: coming to an end of where this explosion of new
Speaker 1: technology allows a handful of growth stocks to just massively
Speaker 1: outperform expectations, and we referred to a period that's a
Speaker 1: little more normal in which the technology is diffused available
Speaker 1: to all. Would we in would you then expect years
Speaker 1: and years and decades potentially of the value factor outperforming.
Speaker 1: That's what we've seen before, right, So I don't want
Speaker 1: to go on and say that value is going to
Speaker 1: go out and have you know, fifty years of out
Speaker 1: performs and and by the way, within that time frame,
Speaker 1: there's obviously shorter periods of time where value works against you.
Speaker 1: What we have seen we use something we call base rates,
Speaker 1: which are the percentage of time over a rolling call it,
Speaker 1: one year, three year, five year, ten year period where
Speaker 1: value has outperformed. Uh. And what we've seen is in
Speaker 1: that call it in between these technological revolutions, it's had
Speaker 1: a significant periods of out performance over rolling ten year basis.
Speaker 1: Like close to mind you on a one year basis,
Speaker 1: it winds up closer in like a sixty to sixty
Speaker 1: I'm curious is regulation the big risk here, because it
Speaker 1: does feel like a lot of technology or innovation at
Speaker 1: least initially starts out as sort of regulatory arbitrage, which
Speaker 1: means it could be affected, um very quickly. Is that
Speaker 1: one thing that you would worry about in this scenario? Actually,
Speaker 1: I think I think I think regulation, Well, let me
Speaker 1: say it's one thing you should think about as an investor.
Speaker 1: For us, we think that that's only gonna if you
Speaker 1: were to call the regulatory risk, it's predominantly on the
Speaker 1: growth side right now, um, because that's where there's going
Speaker 1: to be. You know. Really two parts of that I
Speaker 1: see come through is regulatory risk. One is the anti
Speaker 1: monopolistic where the size of these companies get so big.
Speaker 1: I mean, if Amazon goes through another growth like it
Speaker 1: did over the last ten years, obviously it would wind
Speaker 1: up having with monopolistic anti monopolistic enterprise. But the second one,
Speaker 1: which I think is going to wind up being perhaps
Speaker 1: a little mirror, is this idea of um, people starting
Speaker 1: to understand the trade they're making on their data. UM.
Speaker 1: So that was where Senate it was interesting. I think
Speaker 1: it was within the last month. And again I can't remember.
Speaker 1: I'm terrible with names, so I can't remember who was.
Speaker 1: It was Durban who who have had proposed the bill
Speaker 1: in the Senate where they were going to make transparent
Speaker 1: what people are receiving, you know, for there the value
Speaker 1: of the information you're giving them. Right, this idea of
Speaker 1: people are being tracked on their phones, um, I think
Speaker 1: the general level of awareness of how much is being
Speaker 1: tracked and how much of your of a composite profile
Speaker 1: can be built for you online is being and then
Speaker 1: being utilized. That's going to be potentially where the that's
Speaker 1: gonna have it, where a regulation will come through and
Speaker 1: create transparent to that and perhaps slow that down. I
Speaker 1: wanna shift gears a little bit and throw out a
Speaker 1: theory that someone once told me about the decline of
Speaker 1: the value factor and get your take on it. So
Speaker 1: someone I was years ago was arguing to me was
Speaker 1: that companies can be cheap on a ratios basis for
Speaker 1: multiple reasons. So some companies are doomed like BlackBerry. Others
Speaker 1: are cyclical businesses like mining companies that might be at
Speaker 1: cyclical peaks and so people don't pay too much for
Speaker 1: their earnings. Others are just in unpopular industries such as
Speaker 1: a newspaper and so forth, and they're all different. And
Speaker 1: his argument was that the advantage of investing in that
Speaker 1: basket was that value was essentially a good screen for diversification. Essentially,
Speaker 1: what you guaranteed by buying cheap stocks was that you
Speaker 1: bought a bunch of different companies with different things going on,
Speaker 1: and that was diversified. And that with the emergence of
Speaker 1: value et f s and value funds because people go
Speaker 1: in and out of the factor, they're less diversified. People
Speaker 1: buy all the value stocks at once, and they sell
Speaker 1: them all at once, and they start to correlate more
Speaker 1: merely because they're all in the same funds, and so
Speaker 1: the diversification benefits of value no longer exist because they're
Speaker 1: all tied by the fact that they're all part of
Speaker 1: the same ETFs and the same Does that ring true
Speaker 1: to you at all? Is that something that you've come across,
Speaker 1: like the different reasons why companies are value and whether
Speaker 1: that reduces some of the benefits to the portfolio. You know,
Speaker 1: it's interesting that that. First of all, one, I do
Speaker 1: believe that the original premise that you you said on
Speaker 1: value investing is right. There are stocks within value that
Speaker 1: are secular, cyclical, on popular, you know, doom. I like that,
Speaker 1: I'll keep that one and so that. But there's also
Speaker 1: healthy companies that are priced at a discount because of
Speaker 1: near term fears and that are unfounded. Right, So what
Speaker 1: you're leaving inside of that is that there are healthy
Speaker 1: companies that get you know, baby with bathwater thrown out
Speaker 1: inside of this and can have some significant outperformance along
Speaker 1: the way. That is why it's important to have a
Speaker 1: comprehensive look when looking at value stocks in order to
Speaker 1: have a quality themes that you're putting on top of it.
Speaker 1: Uh and and and a good understanding of of picking
Speaker 1: within value right and understanding which types of stocks you're
Speaker 1: gonna go for and staying away from the doomed right.
Speaker 1: So but on the part value that should be an
Speaker 1: e t F value x doom x doomed. Yes, I
Speaker 1: like that. So but the the part about ETFs essentially
Speaker 1: are being this out right where the benefit of value
Speaker 1: we haven't seen that, right, because what you would expect
Speaker 1: to see is spread scenario um. And what you would
Speaker 1: expect to see is is the number one is spread scenaril.
Speaker 1: But also just knowing how the from my seat, how
Speaker 1: the panoply of ETFs work, which is they wind up
Speaker 1: in different spots, right, so you're gonna wind up with
Speaker 1: some on price to book and yeah, there's some clustering
Speaker 1: around that, and we have concerns about price to book
Speaker 1: as a factor. You know, it's it's better than nothing,
Speaker 1: but there's better value factors that are out there. Um.
Speaker 1: But overall, we have not seen that there's any sort
Speaker 1: of any sort of arbitraging way of the value factor
Speaker 1: from ETFs in those flows. So I have one more question, um,
Speaker 1: And you sort of evaded it earlier, I guess, and
Speaker 1: it's a really tough one. But using all of your
Speaker 1: historical data and the analysis that you've done, which is,
Speaker 1: you know, very detailed, what do you think is going
Speaker 1: to be the turning point in this current cycle that
Speaker 1: is going to actually lead value to outperform once again?
Speaker 1: So the point before I I thought I didn't avoid it.
Speaker 1: I thought I was. I was just being like that.
Speaker 1: It's very listening. At the end of the day, it's
Speaker 1: hard to time. You can't find a specific catalyst where
Speaker 1: that will be it right. You know, it's like, oh,
Speaker 1: you know that, you know Walmart came out with this
Speaker 1: killer app and that did it right? You know, there's
Speaker 1: there's none There's not something like that that I can
Speaker 1: point to. What we have are just looking at the
Speaker 1: trends historically. And this is the benefit of being a
Speaker 1: quant which is I've got ninety two years Dad, I don't.
Speaker 1: I might not have ninety two years of experience, but
Speaker 1: I have ninety two years of data and the ability
Speaker 1: to look with a long historical lens and tie periods
Speaker 1: together and look at what happened, and this idea of yes,
Speaker 1: there are clusters of technological innovation, and yes we're living
Speaker 1: through one of those now right. So at the very least,
Speaker 1: it's giving perspective of we had a period of time
Speaker 1: work growth outperformed value and then it shifted back to
Speaker 1: value out performing growth for a long period of time,
Speaker 1: right and similar So at the very least, that's one perspective.
Speaker 1: If you think there are similarities between those time frames,
Speaker 1: then you know that's one that can give you confidence
Speaker 1: that there was a time frame before where it didn't
Speaker 1: work and then it reverted back. We're living with those
Speaker 1: right now, and there's a chance that I believe a
Speaker 1: strong chance that I will revert back. For the specific
Speaker 1: catalysts on it, we look to a couple of things.
Speaker 1: One is going to be that you see the formation
Speaker 1: of the again, those oligopolies, the winners come out, the
Speaker 1: standards are set. Normal companies, like I say of the
Speaker 1: previous regime, adopt the broad technology and they start having
Speaker 1: it where they participate. And what is the economic boon
Speaker 1: that's created by these new technologies. Yeah, I think about
Speaker 1: Walmart is a good example of a company that a
Speaker 1: lot of people view is actually getting subtraction against Amazon
Speaker 1: for the first time ever. Alright, well, we're going to
Speaker 1: leave it there then, Chris Meredith of O'Shaughnessy Asset Management,
Speaker 1: thanks so much for being on now. Thank you so, Joe.
Speaker 1: One thing I sometimes think about um when we're talking
Speaker 1: about value investing is just like the perception of a
Speaker 1: lot of the value companies as being a bit old fashioned.
Speaker 1: You know, they often make things or produced services, and
Speaker 1: they take up a lot of fixed capital, and when
Speaker 1: you get into a late economic cycle, I think people
Speaker 1: start to think that those companies are going to have
Speaker 1: a really hard timed adapting in a recession or lowering
Speaker 1: their costs. So I often wonder whether or not value
Speaker 1: investings under performance over the past decade or so is
Speaker 1: just about people continuously thinking we're late in the cycle.
Speaker 1: It definitely feels as though the while this cycle or
Speaker 1: this expansion has been one of the longest ever, people
Speaker 1: have been skeptical on it from day one, so people
Speaker 1: were probably calling it late cycle from like two thousand
Speaker 1: eleven or maybe earlier. So there probably is something too
Speaker 1: that I really like the discussion because I think, you know,
Speaker 1: it helps to uh get into sort of some of
Speaker 1: the meat and potatoes of what we talked about when
Speaker 1: we talk about quant stuff or even even value investing
Speaker 1: terms that we throw around, But what are the actual
Speaker 1: component of the trade, What are the signals people are
Speaker 1: trying to find in the data? And you know, it's
Speaker 1: really tempting at a time when Netflix and Facebook are
Speaker 1: ascendant to say, oh, you know, the old company, these
Speaker 1: are doomed and buy the new stuff and sell the
Speaker 1: old stuff. And it takes a lot of discipline. Um
Speaker 1: and some might say it's foolish discipline, but it takes
Speaker 1: a lot of discipline to not just sort of say, oh,
Speaker 1: there's a new paradigm, you gotta dump everything. Yeah, And
Speaker 1: I think, I mean that's basically the crux of this
Speaker 1: whole discussion, right, like is it a cyclical downturn for
Speaker 1: value investing or is it structural? And just on the
Speaker 1: structural point, I mean, there are quite a few things
Speaker 1: that are different this time, one of which is the
Speaker 1: fact that this has been going on for twelve years,
Speaker 1: which I think is unprecedented. But the other big thing
Speaker 1: is if you think that financials are the big underperformers
Speaker 1: of the value investing bucket. In recent years, financials do
Speaker 1: seem to be facing some sort of permanent headwinds to
Speaker 1: their business model, one of which, of course, is low
Speaker 1: interest rates. Right, yeah, Now, I mean this is why
Speaker 1: the debate is so interesting, because I feel like you
Speaker 1: could just go back and forth and make really compelling
Speaker 1: cases either for this time is different or it feels different,
Speaker 1: but it's felt different before. This is sort of like
Speaker 1: the known unknowns quote. We'll have to follow up with
Speaker 1: Chris and ten years and then I think we'll have
Speaker 1: a definitive answer to the debate. Well maybe, or maybe
Speaker 1: we'll still be talking about under performance then who knows? Um?
Speaker 1: All right, shall we leave it there? Let's leave it there,
Speaker 1: all right? This has been another episode of the ad
Speaker 1: Thoughts podcast. I'm Tracy Alloway. You can follow me on
Speaker 1: Twitter at Tracy Alloway and I'm Joe wisn't All. You
Speaker 1: can follow me on Twitter at the Stalwart, and you
Speaker 1: should follow our guest on Twitter, Chris Meredith. He's at
Speaker 1: Chris Meredith twenty three. And be sure to follow our
Speaker 1: producer on Twitter, Laura Carlson. She's at Laura m Carlson,
Speaker 1: as well as the Bloomberg head of podcasts, Francesca Leavi
Speaker 1: at Francesca Today and check out the new home of
Speaker 1: Bloomberg podcast on Twitter with the handle at podcasts. Thanks
Speaker 1: for listening to