Will 2022 Be the 12 months of Worth Investing? By Investing.com
By Marcin Jendrzejczak with Katarzyna Plewa
The New Year 2022 is an opportunity to reflect deeply and make resolutions. This also applies to investment decisions. In this context, it is worth refreshing the value investing philosophy and considering whether it will regain its former glory after the unfavorable years in 2022.
Value investing is a classic investment strategy, just like its counterpart, growth investing. It consists of buying companies that are trading at a lower price than their real value. The classic example is buying at a price below book value. In this case, you’re talking about buying a dollar for a penny: the stock represents part of the property of a particular company – its factories, patents, and other assets, which in this case are bought at a price lower than their actual value as stated on the balance sheet.
The psychology of value investing
Value investing is the investment strategy of Warren Buffett and his mentor Benjamin Graham. Value investing requires a long-term perspective. Economists speak of a low time preference here. The idea is that everyone prefers present goods over future goods. This preference can be stronger or weaker. In the latter case, a person is able to sacrifice part of their present income for future income on the condition of chance of winning.
A value investor cannot shy away from taking action against the crowd, because he follows the principle “Buy when blood flows on the streets”. Sir John Templeton called this the principle of maximum pessimism. He did not encourage buying stocks until the market was fully convinced of the total hopelessness that it entailed.
Value stocks don’t always go up immediately. As Benjamin Graham (NYSE 🙂 said, the market is a voting machine in the short term, but a Libra in the long term. In the short term, the shares can therefore fall even further. At the end of the day, however, stock prices and valuations should align.
The long-term benefit of value investing
Value companies tend to win over the long term and really win over the long term. According to Bank of America, value investments have produced 1,344,600% returns since 1926. In the same period, investments in growth “only” achieved a return of 626,600%.
As Craig L. Israelsen noted in an article summarizing the research and published on the Financial Planning website, the cumulative annual growth of the over 25 years (1990-2014) was 9.62% and the standard deviation was 18.25%. This means that the investment has grown from $ 10,000 to $ 99,350 after 25 years (real return was lower due to inflation). Value investing earned a premium of 86 basis points for large US companies. For medium-sized companies, the premium was 99 basis points. For small companies it was even 224 basis points.
In addition, the author examined the situation in 21 periods of 5 years within the period studied. In the large company category, value companies “won” 52% of the time. Among small businesses, Value was the winner 76% of the 5-year periods (although over the 1995-1999 period when growth companies gained, they were up to 860 basis points ahead).
Therefore, two principles emerge from research. First, the longer the periods, the higher the chance of a value investment advantage. Second, the smaller the companies we consider, the greater the benefit.
The last decade – exception or new rule?
However, this has become less obvious. Lately, growth investing has outperformed value investing. For example, over the past decade, the iShares Russell 1000 Growth Index (NYSE 🙂 has returned 17% annually, while the iShares Russell 1000 Value Index (NYSE 🙂 has only returned 10%. Some analysts see this as a fundamental shift in markets caused by technology companies. Others recall that the same argument was made shortly before the dot-com bubble burst in 2000.
So has the world changed? As proponents of the so-called New Economy emphasize, it is no longer real capital that counts today, but human capital. This makes traditional ratios such as price / profit or price / book value obsolete. An IT company might not have a lot of capital, but it can still be great business. This is because its capital is in people’s minds. “Asset-light” is positive for modern companies, not a disadvantage.
So let’s take a closer look at the case. Our backtest on the Portfolio Visualizer portal for the 2011-21 period showed that an investment of $ 10,000 in an ETF representing large (from the SP500 index) US growth companies would cost $ 58,056 at the end of 2021 brought in. In contrast, an investment in the iShares returned the S&P 500 Value ETF (NYSE :), which represents large US value companies, grossed $ 31,764 at the end of the reporting period.
However, for the first half of the decade, the results were even. The lion’s share of the difference is therefore attributable to the last half of the decade, especially the period since April 2020. After all, the growth advantage was still just under $ 8,882 on March 30, 2020 and rose to $ 26,292 by March 30, the end of it 2021.
The comparison in the small-cap category is similar – the iShares S&P Small-Cap 600 Value ETF (NYSE 🙂 versus the iShares S&P Small-Cap 600 Growth ETF (NASDAQ :). The cumulative annual returns are 11.56% and 13.64%, respectively, and the $ 10,000 investment brought in $ 7,383 more for the small-cap growth investments at the end of the reporting period. Here, too, the two portfolios were very well coordinated until 2017. Only then did the divergence begin.
In contrast, the iShares S&P Mid-Cap 400 Growth ETF (NYSE 🙂 had a cumulative annual return of 12.49% and the $ 10,000 invested brought in $ 36,142, while the iShares S&P Mid-Cap 400 Value ETF (NYSE 🙂 had a cumulative annual return of 11.27% and the $ 10,000 invested returned $ 32,076 at the end of the period. In this case, the charts were very even until the end of March 2020.
The proliferation of growth companies in recent years seems less of a trend change and more of an anomaly. It was hit with non-standard monetary policies, such as asset purchase programs and negative real interest rates (and extremely low nominal interest rates). The correlation with the decisions of the Fed in spring 2020 is striking here. It is difficult to speak of coincidence here – rather, a cause-and-effect relationship is obvious. For the gigantic evaluations of growth companies in recent years and especially after 2020, it is not a paradigm shift in the economy, but a change in Fed policy that is primarily responsible.
Thus, the Fed’s withdrawal from radically cautious policies threatens a deep correction for growth companies. The higher the overvaluation, the stronger the correction will be. Recall that the Fed currently expects to end the asset purchase program at the end of the first quarter of 2022, followed by rate hikes through 2022 and 2023. Of course, one can imagine a situation where, if the market reaction is too negative, the central bank will revert to its old policy. However, record high inflation will be a difficult barrier to overcome in recent years.
Thus, the recent strong growth of the companies is even an additional argument for the fact that the next few years will belong to the value companies again. Likewise, an overvaluation of the US market can lead to capital flows into less popular emerging markets. Value investors find interesting companies not only in the expensive American market, but also in Latin America, Russia, the Czech Republic and Poland.
The growth disparity: Not just in America
It is worth remembering, however, that unrealistically high growth company valuations are not just a US problem. As Anthony Luzio of Trustnet Magazine points out, the price / earnings ratio for the MSCI Growth index of global growth stocks is currently 37.7, which is 2.5 times more than its value counterpart. While growth stocks are essentially more expensive by definition, the difference is typically 1.4x. It’s now 2.5X. Even when we take a global perspective, we find that growth stocks are more than usual overvalued.
Of course, this is just a hypothesis. The only thing we know for sure about the future is its uncertainty. Additionally, growth companies, often associated with technology, can produce truly remarkable returns in the short term. Most experts also suggest diversifying your portfolio. There is room for different types of companies in a diversified portfolio, although there is nothing to prevent one type from predominating.
In conclusion, it is important to remember that even if we have a value investment philosophy based on historical data, common sense and big names, we shouldn’t limit ourselves to these. A low rating is an important, but not the only, indicator of a company’s future success. No less important is size (usually smaller companies generate higher profits, but with higher volatility); Quality (good company finances) and the momentum factor (what grew last year often continues to grow in the next). Someone might advise that a portfolio should include growth companies but should be chosen very carefully or invested as part of ETFs. Then we don’t have to rely on a single company, which can often go from today’s market darling to tomorrow’s bankruptcy. The growth companies of today include the Amazons of tomorrow, but also many companies that will not thrive or perhaps even survive.
In a way, the ideal seems like a small, good quality company – with good finances, cheap, but whose share price has already started to recover. As we can see, there are many signs that 2022 will usher in a return to value investing, and the new year is a good opportunity to create an investment plan based on professional reviews and analyst opinions. As always, the keys to success remain patience, common sense, avoiding greed, and investing only as much as you can afford to lose.