The Millstone Times April 2019

Millennials Redefine Value in The Stock Market An examination of Growth’s outperformance of Value and what it tells us about the economy . “Be fearful when others are greedy, and greedy when others are fearful.”- Warren Buffett Investment experts are fond of spouting fancy terms and acronyms, often baffling the public, their clients, and even themselves. The building blocks supporting much of this financial jargon are Value and Growth. These two schools of thought have a cult-like following akin to asking a stock picker to either root for the Yankees or the Red Sox, there’s no in between. One might ask how you could go wrong picking a stock or fund deemed a “Value”, after all who doesn’t like a good deal? Conversely how could you screw up picking “Growth”, is expansion not the goal of every investor? Value Investing is the practice of selecting stocks or sectors believed to be trading below their intrinsic value, at a discount. Perhaps the most admired stock picker of all time, Warren Buffett, as well as his mentor, Benjamin Graham, have built an empire on searching for Value. These are investors who try to make their money on the Buy, purchasing companies at such a relatively low price that even a return to normal will secure a profit. From a technical standpoint, these are assets that have a lower than average Price-to-Book or Price-to-Earnings (P/E) Ratio. Proponents of this strategy believe in seizing on a false reaction to stock price based on human emotion. Growth Investing takes the above philosophy and throws it out the window. Such investors ignore high multiples and soaring prices, anticipating even more appreciation. Thomas Rowe Price Jr. (founder of T. Rowe Price) is most often connected to this mentality. Where fans of Value obsess over raw numbers, advocates of Growth rely on hope and momentum. Algorithms and stochastic research may dominate Wall Street, but at the end of the day these are two separate emotional decisions playing off one another. Investors from college kids on their Robin Hood app all the way up to hedge fund managers placing billion-dollar trades are ultimately con- vincing themselves that the underlying stock must fall into their category and that their category must have a bright future. Sadly, history has shown us that neither bet carries certainty. From the Great Depression up through the Great Recession, Value stocks have steadily outperformed Growth. However, in recent history the tables have turned. Since the lowest point of the Great Recession, the Large Cap Growth sector has returned 418.3%. During the same timeframe, Value has yielded 341.7%. Why the sudden shift and what does that mean for the economy? In one word, technology. The FANG stocks (Facebook, Amazon, Netflix, Google) and their counterparts have transcended the way we communicate, shop, handle business, educate, and conduct every other facet of life. A tech company does not need to own 100 million square feet of office space and manufacturing equipment, it can survive and even thrive on just an idea. Hence the huge disparity between market value and underlying hard assets. Consumers want innovation and they want it now, regardless of how outlandish the idea may seem (i.e. Tesla). Such confidence and embracement of technology has redefined an “expensive” stock.

Meanwhile, the value kingdom of Berkshire Hathaway sits on over $100 billion of cash viewing available deals as overpriced, as these tech companies continue to soar. Who needs all those Macy’s storefronts? Why go through the hassle of running to the bank when it can be done online? Why hail a cab in the middle of traffic when I can click Uber? Where does this trickledown effect end? Do I need to spend $2 million on a house near the city when I can skip the commute and skype my team from a $200k beachfront home in North Carolina? Investors can always excuse a loss as an outlier or a mere point in time statistics didn’t make sense. But for how long? A month, a year, perhaps even a decade? The Oracle from Omaha’s Berkshire Hathaway has not beaten the SP500 in the past one- year, three-year, five-year, or even nine-year periods. Was Berkshire’s 2016 invest- ment in Apple a small abandonment from the gospel, jumping aboard a 30-year old tech boom. Beware as the markets can act irrational much longer than you can stay solvent. Even scarier is the redefining of rational. A discounted stock might be discounted because it’s about to go belly up. That’s right, not every company has to return to “normal”, they may just go away. An expensive stock might be expensive in the tra- ditional sense, but have years to run before it’s overvalued. So, before you pick your next investment, carefully weigh the growth potential of a value versus the value of a growth.

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The Millstone Times

April 2019