“Value investing is dead” is a common refrain you hear these days. Traditional strategies around buying stocks with low Price to Earnings Ratios or low Price to Book Ratios have been trounced by Growth Strategies in the last five to ten years, but especially the last year during COVID. Performance of these “value” stocks are bemoaned by value investors, while growth investors snicker with glee.
What is remarkably absent from the argument around value investing is that within certain sectors, value investing is alive and flourishing. (Please excuse me while I repeat myself about certain companies that I have already written about, but it turns out they are shining examples to prove my point!)
The best sector to see this phenomenon is the technology sector.
In 2016, as the above article shows there was concerns that Apple (NASDAQ: AAPL) was a value stock! Warren Buffett bought an enormous stake in the company. Fast forward to today and Apple is a “growth” stock (and it also now represents 24% of Berkshire’s entire market cap).
Five years ago, Microsoft (NASDAQ: MSFT) sold for a P/E multiple that was around 10 times earnings, as it was left for dead and could do nothing right in the market’s eyes. Then its stock price proceeded to increase five times in the ensuing five years. Now it is a “growth” stock.
It’s clear that value investing can clearly work in the technology sector. I think it is important to examine why a technology company’s valuation becomes cheap in the first place, so in the future we can identify opportunities. There appear to be three main reasons a technology company becomes undervalued.
The first is that these companies are not acting like or being the cool kids on the block that the market wants them to be in that moment. Market narratives change and investor perceptions are often fickle. Remember when Microsoft could do nothing right compared to Apple? Or that Tim Cook was not the visionary that Steve Jobs was? Now everyone wants to be an investor in Microsoft and Apple, but it wasn’t always the case.
The second reason a technology company may be undervalued is being located outside of the U.S. Based in Kyoto, Japan and with limited investor relations, Nintendo (Japan: 7974, US OTC: NTDOY) has been and continues to be very undervalued in my humble opinion and despite a 100% increase in value in the last 18 months, it still sells for 13 times my estimate of this year’s earnings, excluding its cash and investments. Value investors should be looking abroad as valuations are substantially less than in the U.S.
The third reason is that some technology companies fly under the radar or appear to be in a different industry. An example here is Nelnet (NYSE: NNI). Nelnet screens like it is a financial services company but is actually a fast-growing technology company. I have written up how Nelnet is undervalued as a technology investment. It is up 50% from my report and is still seriously undervalued in my opinion.
But technology isn’t the only fast-growing sector where you can find value. Cannabis is another booming sector with a ton of growth ahead of it. I have highlighted that cannabis companies are reporting software-like margins and that AYR Strategies (Canada: AYR, OTC: AYRSF) is a very attractive value stock. AYR Strategies has been on a monster run, but still trades at only 5.2 times next year’s cash flow, despite the potential for 100% cash flow growth next year.
What do the cannabis and technology sectors have in common? Both sectors are experiencing tremendous growth and COVID has been an accelerant to that growth, pulling forward years’ worth of adoption.
And this started me thinking, maybe the problem isn’t in value investing per se, but with industries that are dying or in secular decline? What happens when you pursue a value strategy, but you end up with a portfolio of companies in industries with little or no growth. Or worse, negative growth? It shouldn’t be surprising to find that you were underperforming.
There is a strong argument that fossil fuel investing is dead or is a dying sector. I am skeptical of that thesis, especially around natural gas, which is why I like Black Stone Minerals, it has a heavy concentration in natural gas. But I can’t help but notice that BSM has gone nowhere in this market rally despite a 9%+ yield and a clean balance sheet.
So, where does this leave value investors? I think it starts with knowing that value investing is very much alive these days but the “alpha” or outperformance may not be in dying or contracting industries. Value investing is thriving, but right now it is found where there is growth.
P.S. All that being said, we may be near the point where the pendulum starts to swing back towards broader value strategies. Either way value is out there.