23rd September 2019

Schroders: Has value investing been disrupted?

Disruption is a major theme in stock markets today with companies such as Amazon and Uber challenging the traditional approach to their respective industries. Such companies are an example of so-called "growth" stocks, with investors attracted by their prospects for expansion and future revenue growth.

Investors in “value” stocks, in contrast, focus less on a company’s future prospects and more on its current valuation and financial strength.

Critics of value investing argue that, since the technological innovation that is often associated with growth stocks is essential in today’s world, companies without it are unlikely to be the top performers in the future.

Good companies vs good investments

It’s certainly true that older businesses are less likely to be the fast growers of the future. But this overlooks an absolutely crucial distinction between good companies and good investments. 

For example, is UK supermarket chain Tesco being disrupted? It certainly is, due to the expansion of discount retailers such as Aldi and Lidl and the move to food shopping online. However, this didn’t stop the shares going from £1.40 in January 2016 to £2.60 in August 2018. Disruption may stop the shares getting back up to £5.00, but as long as you don’t expect that to happen, you won’t be disappointed.

The broader point in the frothy markets that we are experiencing today is that companies with better technology, higher potential future earnings and the ability to disrupt incumbents do not justify unbounded valuations. They can be very successful businesses while simultaneously being very dangerous investments.

The world is always changing, but that hasn’t stopped the value investment style outperforming for past 150 years. The chart below shows US stocks split by their starting price-to-earnings ratio, and their subsequent 10-year return. A lower P/E indicates a cheaper price. As we can see, the stocks with the lowest P/E (0-7) delivered the highest returns in the following ten-year period.

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Investment Commentary, Investments