If you have been around the investing game for any length of time, you know that one of the most heated and never-ending debates is whether value or growth investing provides the best strategy. Despite the growing chorus of voices decrying the death of value investing, the hard evidence patently indicates that value investing trumps growth investing over the long term—hands down.
With reports now indicating that as much as 80% of market transactions are now machine to machine, it may appear that the algos and are in and the human is out. With this thesis comes the boisterous declarations that:
If you listened to all the noise, you would come away believing that we are going to need a much bigger graveyard to hold all the financial stuff that has apparently “died” as of late.
To borrow a line from Mark Twain, I’m here to declare that the reports of value investing’s demise have been greatly exaggerated!
The truth is that there is no such thing as purely passive investing—just less active. At some level, decisions must always be made and/or algos programmed. Thus, the “active” manager—whether institutional or retail—can’t be dead. Yes, you can argue that the level of activity has contracted… but it has not, nor will it ever, fully go away.
Fueling these urban legends (e.g., the death of active managers and value) is the apparent meteoric rise of “passive” investing (aka index investing). However, the problem is that liquidity fuels passive investment—providing a short-run picture that is highly distorted. It’s like pumping oxygen into a fire!
These “passive” vehicles are still rules-based. This means they must buy certain holdings—even if it’s not smart. For example, as money flows into the SPY (a cap-weighted index), it must buy more of its overvalued holdings—making them even more overvalued. Conversely, it buys less of its undervalued holdings—making them even more undervalued.
Thus, it is a self-perpetuating cycle… for a time (or a season). Liquidity fuels passive investing. Passive investing fuels PE expansion (largely impacting overvalued growth stocks). This expansion fuels further liquidity, which fuels more inflows to passive investing… and the cycle repeats ad nauseum.
What was just created? A bubble. And what happens to bubbles?
Yup, they eventually pop. And once the cycle reverses—and it always does, it becomes a viscous unwinding as all that wonderful and glorious liquidity dries up. After all, “passive” is rules-based. As all that capital that once flowed in now flows out, the indexes must sell—indiscriminately. This means the expansion becomes a contraction (a mean reversion), with those high-flying growth stocks that expanded the most now contracting the most.
Add the Fed’s multiple rounds of quantitative easing (QE) to this and combine with massive stock buy-backs (encouraged by politicians and fueled by absurdly low levels), and you not only have a little liquidity—you have a massive injection of liquidity over the past decade!
In fact, it is estimated that over half (more than 50%) of market gains since the financial crisis are the direct product of corporate buy-backs (paid for by cheap debt)—not new investment capital.
Furthermore, all this liquidity specifically favors growth stocks—their PEs expand the most (thanks to passive investing) and they are the primary beneficiaries of stock buy-backs.
There should be little surprise at the results—a massive bull run and a golden decade for growth investing. However, just because growth has outperformed in the short-run does not mean it will continue or that value is dead… that would require a mighty (and foolish) leap of logic.
Remember, it’s a bubble. I’m not saying that’s good or bad… it simply is what it is. And bubbles will do what bubbles do… they will expand until they eventually pop.
Liquidity is the catalyst—one that generates an intense fire. However, like any fire, when the underlying fuel is consumed and runs out… the fire will be extinguished (usually fairly quickly).
For a decade, growth has been the winning ticket. Unfortunately, and unbeknownst to the swelling ranks of new investors, that decade represents a very small sample size. Don’t fall prey to recency bias—you’ll pay dearly for it over longer time-horizons.
Despite the recent success produced by growth investing, the empirical data clearly demonstrates that value is the best investing strategy over long periods of time. In fact, since 1961, value has outperformed growth 76% of the time:
Clearly, the post-financial crisis period has not been a period of strong value performance. As we noted, it has been a short-run period of high liquidity—favoring passive and growth investing.
However, what this information does demonstrates is that value doesn’t die—it just goes out of favor and into hibernation for a season. But like any good sleeping bear… it will inevitably wake up and roar back to life.
Over a much larger sample size, value is the unambiguous winner.
Why? Because when you buy something below its intrinsic value, it will eventually accrete back to fair value, or possibly higher. It’s not rocket science—just financial common sense.
On the other hand, growth investing is predicated on buying something that’s selling at more than fair value and hoping that it will get even more overvalued. In other words, hoping that there will be a bigger fool left for you to sell to when the music stops and that dreaded reversal finally arrives. That’s a bad long-term investing strategy folks. It can work during short momentum-fueled periods (with excessive liquidity), but a value strategy will always outperform over long periods.
Value investing is also predicated on taking more intelligent risk. This is because you have a margin of safety (MOS). With growth investing, you have zero MOS!
Furthermore, value investing does not require that elusive (arguably imaginary) skill known as market timing.
Finally, with growth investing, you are knowingly and intentionally engaging in herding. In fact, you need the herd—your very investing success depends on that herd keeping the music (momentum) going.
Unfortunately, the reality is that when you live by the herd, you die by the herd. When the herd takes a left turn at Albuquerque and heads for the emergency exit, that door always turns out to be really small! Liquidity will evaporate faster than you could imagine, and you will inevitably resort to panic selling—likely at a price-point far below what you paid when that herd seemed like a great bunch of fellow grazers to hang with.
And I’m not talking about a market crash… just a run-of-the-mill bear market.
Even if you don’t sell and manage to hold what you have… it may not end up as well for you as you might think. If you bought the big four at the peak of the dot.com bubble 20+ years ago (those “couldn’t lose” stocks of Cisco, Intel, Microsoft and Qualcom—sound like FANG today?), you would—even if you faithfully held them—still be underwater today!
The broad lesson of history: Value trumps growth over the long run!
If you time the passive, self-perpetuating cycle just right, you can make money over the short run—potentially a lot of money.
However, the pink elephant in the room is that most investors can’t and don’t. They pile in high (late in the cycle) and panic-sell low when the cycle reverses, turns vicious, and the blood starts flowing in the streets.
The reality is that the future is unknowable—even to the greatest of investors. Furthermore, successfully timing unknown market events is a fool’s errand. It sounds great as a marketing slogan to sell you a product or service, but it’s akin to Don Quixote’s impossible dream—it’s imaginary! You’d be better off investing your capital into an expedition to search for purple unicorns living at the end of rainbows.
The real, unadulterated truth is that all we can do is utilize an investing strategy/process that enables us to:
It’s not about being right or wrong—it’s about taking intelligent risk. A priori, investing success is all about process and mindset. Judging your outcome (whether you were right or wrong), while important for continuously improving our process and mindset, is completely ex-posteriori.
And, it is value investing that provides the best opportunity for good process, good decision-making, and a good outcome.
This doesn’t mean we’ll always be right… but who cares! Perfection is an unrealistic and unobtainable standard. What matters is (1) minimizing losses when we’re wrong, (2) being right more than we’re wrong, and (3) maximizing our gains when we win. If we do this, we will be highly successful long-term investors. Value investing provides the best opportunity to check these boxes.
How do you compete against algos and the proliferation of passive vehicles? How do you outperform in a market dominated by index-based mediocrity? How do you beat the big institutions as a small retail investor?
You buy quality companies at a value and hold them—capitalizing on your biggest edge… time arbitrage.
Invest in value and you will win. You may not win today, or next year… but you will win in the long run—even if you’re not right all the time.
No one can say when the short-run, liquidity-fueled, growth cycle will end… but it will end.
And when it does, there will be a value rebirth or renaissance—though it never really died.
If you have a short investing time horizon, then there are periods where growth can and will outperform value. By all means, capitalize on it if you can—just understand the difficulties and risks inherent in trying to do so.
But don’t be lulled to sleep or fooled into believing the “good” times are here to stay and value is dead—you will pay a high price for doing so.
The short-run cycle will inevitably give way to the long-run reality that value still matters (it always has and always will). And those pesky, reclusive, and boring value investors—despised, belittled, and presumed lost at sea and dead by the passive growth pundits—will once again rise from the grave to outperform their growth compadres.
All that work you invested into the growth strategy—if you were even lucky enough to achieve some success—will none-the-less wind up underperforming a value strategy over the long run.
Value always trumps growth investing when it comes to long-term investing.
It just requires patience, a contrarian mindset, and a high degree of intestinal fortitude to capture it!
Despite all the differences between value and growth investing, they share one pivotal characteristic in common: they are both predicated entirely on capital appreciation.
This means that both require you to wait—sometimes a long time—to recognize any realized (i.e., actual cash) gains. This presents a major drawback: your investment capital is sitting idle (a) while you wait for that capital appreciation to materialize and (b) until you sell shares to capture those paper gains.
However, there is another option—dividend-growth investing. Unlike growth and value investing, DGI is an income strategy. In other words, your capital provides you with passive income (real cash) while you wait for either growth to materialize or the market to recognize the value you have identified.
There are two critical corollaries to this:
The first is a benefit because it allows you to (a) preserve a low cost-basis over longer time horizons and (b) build an ever-expanding portfolio—one that can be passed to future generations (i.e., generational wealth). It is hard to wrap your mind around, but an income strategy enables you to tap into a never-ending (and exponentially growing) stream of passive-income… one that never requires you to liquidate the underlying asset(s) producing that income!
Again, with a pure growth or value strategy, you get nothing until you capture your unrealized gain by selling the underlying asset(s)… and nothing more. That’s it. The cash cow is dead, and you have to start all over again with a new calf—hoping you select a good one and waiting for it to mature into a new cash cow.
The second corollary is important because it allows you to capture the power of compounding more efficiently and without the need for capital appreciation. You compound your gains (real passive income) with every dividend payment. However, with pure value and growth investing, you only compound when you capture a gain by liquidating shares. In other words, dividend-growth investing provides long-term investors with the best of both worlds!
However, it is important to note that, even within DGI, the two concepts (or sides of the coin) of value and growth still exist. You can target “value” dividend-paying stocks, “growth” dividend-paying stocks, or a mix (allocation) of the two. You have a wide spectrum of opportunities that can be tailored to your unique goals, personality, and risk profile/tolerance.
Value dividend stocks provide you with higher yields, but less potential future growth (or at least slower growth). On the other hand, growth dividend stocks tend to have lower yields but greater potential for future growth (or at least at a faster pace). It’s a now-or-later proposition and your unique allocation strategy will be significantly shaped by your investing time horizon.
Regardless of which type (or mix of the two) you integrate into your DGI plan, the key is trying to purchase them at as much of a discount to fair value as possible. This provides you with that all-important margin of safety (MOS)—limiting your downside risk.
In essence, dividend-growth investing is just a subset of value investing. You are looking for value but filtering your options for dividend-paying companies. However, you are still capitalizing on growth (just focusing on passive-income dividend growth), as well as the possibility for capital appreciation (which you can chose to capture down the road or continue to allow it to build).
Obviously, I recommend utilizing this income-investing (DGI) approach—at least as part of your overall investing plan. I believe this approach to long-term investing provides the best foundation for your investing. You can then build additional portfolios (e.g., pure growth or value ones) on top of it in a layered approach—just smaller in size due to the increasing level of risk. This will provide you with a comprehensive investing pyramid—covering multiple approaches and time-horizons.
Reports of value investing’s demise are both grossly premature and greatly exaggerated!
The empirical data tells a very different story—one those new to the investing game need to carefully consider! This data clearly demonstrates that value is the best investing strategy over long periods of time. In fact, since 1961, value has outperformed growth 76% of the time.
Add to this the fact that the vast majority of retail investors fail miserably when it comes to timing the markets—a requirement to really succeed at growth investing, and the picture becomes crystal clear: value investing trumps growth investing for long-term investing.
In fact, value investing provides the best opportunity for good process, good decision-making, and a good outcome.
How do you compete against algos and the proliferation of passive vehicles? How do you outperform in a market dominated by index-based mediocrity? How do you avoid becoming a victim of the current liquidity bubble? You buy quality companies at a value and hold them.
Invest in value and you will win. You may not win today, or next year… but you will win in the long run—even if you’re not right all the time.
Finally, I would argue that the best way to capitalize on value is through dividend-growth investing. Rather than a pure value approach, this strategy allows you to focus on building passive-income rather than depending purely on capital appreciation—allowing you to leverage the power of compounding in a much more efficient manner.
If you’re looking for more insights into dividend-growth investing, then you’re in the right place!
At Wicked Capital, we focus exclusively on helping others become as successful as possible with dividend-growth investing and we hope you’ll continue to return to our site to learn, grow, sharpen your skills, and find effective and positive ideas and motivation!
Soak it all in, take and use what you want, modify it to fit your unique situation, and keep building that DGI portfolio with a solid process and winning long-term investing mindset!
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