Tesla is an extreme example of a growth company. Photo by Chad Russell from Pexels.
Tesla, the electric car, battery, and solar roof company, is up over 300% this year. Their recently disclosed plans to build a new car factory in the Austin area has raised our clients’ interest in Elon Musk’s little spark car venture even further. Just this week, after announcing a 5 for 1 stock split, the stock has gone up over 20% through yesterday’s close. If you are wondering why you didn’t buy some of that before it took off, you’re probably not alone. For value investors, the room for second guessing has gotten quite crowded.
Value investing, or buying stocks that are less expensive versus their book value/earnings/sales etc, has been out of favor for over a decade. Stocks like Tesla that are expected to grow (or go bankrupt, depending on who you ask) at rapid rates have drawn more interest as investors have increasingly been willing to pay seemingly any price for that future growth potential. The Russell 3000 Value Index has lagged the Russell 3000 Growth Index by an eye-popping 30.64% year to date through the end of July. It hasn’t just been this year, though, as value stocks have lagged growth stocks by around 7% per year on average for the past decade. That's enough to try even Job’s patience. In fact, we are experiencing the longest period in history of value underperformance versus growth.
Some experts claim that value investing is dead. They cite reasons ranging from stock buybacks, near zero interest rates, and market efficiency as reasons that investing in companies that are cheaper relative to their expected earnings or assets doesn’t work any more.
But having some perspective of history can help remind us that patience can also be a virtue. Over the last century or so, other disappointing periods for value investing have emerged from time to time. Periods such as the tech bubble in the late 90’s and the housing bubble in the mid-2000’s come to mind. However, the principle that lower relative prices lead to higher expected returns remains the same. On average, value stocks have outperformed growth stocks by 4.54% annually in the US since 1928, as Exhibit 1 shows.
Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Image courtesy of Dimensional Funds.
What we see in Exhibit 1 is that higher returns realized from value investing, also known as the value premium, are highly volatile. While periods like this year, or even the last decade, are disappointing for those that follow the value approach, they are also within the range of expected possible outcomes.
Value investing is based on the premise that paying less for future cash flows is associated with a higher expected return. That’s one of the most basic fundamentals of investing. Combining those basics with a long history of empirical data on the value premium leads us to believe that tilting portfolios toward value stocks continues to be a sound way for investors to increase expected returns going forward.
As for Tesla, I am saving my money for one of those Blade Runner pickups they are going to build in that new local factory.
If you would like to discuss Teslas or your portfolio, get in touch for a review.