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Growth or Value? The Case for a Shift to Value


It is understood by many that the market discounts future events. However, discounting negative future events is done to such an extreme level that opportunities become so glaring that they are missed by the masses from the flood of negative expectations. The negative feedback loop is far more powerful than the positive feedback loop due to our predisposition to negativity bias. It is more pronounced now due to proliferation of information. The combination of a negativity bias, the multiple effectiveness of despair headlines, and the ultimate herd mentality in which investors believe the market or others have more knowledge than they do has created a potential cyclical opportunity not seen in over a decade.

For those who have been value-based investors, it has been a struggle relative to growth investing. Standard & Poor's breaks its index into two classifications: growth and value. When we monitor outperformance, we notice some long-term trends that give us clues about where to place emphasis going forward. The chart below shows the S&P growth index divided by the S&P value index since 1995 broken into three discernible periods.

lloyd1_010819
Past performance is not indicative of future results.

The value component has averaged a 6.87% annualized total return since June 1995 while the growth component has averaged an 8.40% annualized return. Yet when we break it down into long-term cycles, we see extreme outperformance in one category over the other. We believe it is best to “zig” when the majority says, “Zag is the only way and zig has died.”

In discerning value-based investments, look at some of the categories’ following characteristics:

  • Dividend Dividend Dividend. When growth outperforms the value of dividends to a total return are marginalized and forgotten about. As determined above, one does not need to necessarily select certain industries over others. Those whose dividend yields are higher combined with healthy cash flow to keep this yield sustainable has been a historic effective quality screen.
  • Lower price-to-sales ratios with an elevated current ratio (short-term liquidity) often reveals those companies that can withstand and adjust to broader economic downturns. This has occurred on a broad base since The Great Recession.

    lloyd2_010819

  • Increasing cash flows relative to certain growth measures is forgotten until it is the most important. The resource that is scarcest often becomes the most valuable when every largely accepted quality has become commoditized.

We see value in places that are not based solely on price levels. The elongated economic and market cycle has revealed a few things:

  • The typical economic cycle patterns must be compensated for in a subjective matter. In a world where the mantra is to quantitatively evaluate risk and reward, the gray area is often the most telling. Though the increased data available and ability to coagulate it is great, the interpretation of that data and the action that corresponds to it is the most valuable trait.
  • There is an increased sensitivity to risk following The Great Recession and as such, an increased amount of confusing hiccups for more serious conditions. So more rolling corrections and an increased amount of flight to safety during these expansions is more the norm than not. This is evident by the all-time high in households holding U.S. Treasuries, which as of the third quarter came in at $2.3 trillion dollars. This is a 19-fold increase since the end of the recession in June 2009 where it was at $120 billion.
  • Lastly, the amount of U.S. stock buybacks just breached $800 billion on a year-over-year basis. Much of this has to do with the repatriation of cash from the tax law changes in 2018, however, an interesting note should be made here currently. There is a three-month lag to the data, so we don’t have 4th quarter 2018 data, but consider what happened in the difference between the 2nd quarter (Q2) of 2018 and the 3rd quarter (Q3) of 2018.
  •  

    Q2 2018

    Q3 2018

    % change

    Total Value bought back

    $219.09 billion

    $237.6 billion

    8.44%

    Total Shares bought back

    3,187 m shares

    3,703 m shares

    16.2%

    Average Price bought back

    $68.72

    $64.15

    -6.65%

    Source: AAM, Insider Score data

    Initial estimates for the 4th quarter are the average price paid for stock buybacks is coming in at $46.25 per share, or a 28% decline. If there is an 8.4% increase surge in value on a decline of 6.65% in price, what might happen in the buyback if the average price is down 28%?

What we see is the market has given us an opportunity for those with longer term horizons than that those of the high frequency trading group. It may not play out immediately, but the long-term opportunity in value-based equities with a focus on dividends and solid balance sheets may be timely.

 

CRN: 2019-0107-7139R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

 

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