Following the March market mayhem, an equally sharp recovery has reinvigorated the never-ending “Growth vs Value” debate. Which investing style will outperform? Which style is better than the other? Which one is dead? It is such debates that make up the market. If everyone had the same view, we would have a perfectly efficient market with no room for investors to benefit. For one to be qualified as an investor amongst the many participants in the market, it is important that we understand what investing truly is.
While we are aware of all the parlance - quality, growth, value, deep value, momentum, and so forth - we prefer to define investing using first principles. This way of thinking dictates that investing is simply buying a quality/good asset for less than its worth. Quality/good assets by definition includes criteria such as balance sheet strength, sustainable competitive advantage, revenue and earnings growth, return on equity, and competent management. An asset’s worth is a derivative of all these variables together. Without understanding these variables with reasonable certainty, how does one value any asset? For the naysayers, we are curious about their definition of investing. We are certain that no investor (note that we do not mention all market participants) wishes to buy poor assets at a low price or good assets above their true worth – both of these are definite recipes for losing money, unless one is randomly lucky all the time.
If one agrees with this definition of investing, the more difficult task of using this definition to one’s benefit lies ahead. The difficulty arises primarily because of the following:
- What may seem good to one, may seem not so good to someone else. Quality/good assets may come across as a discretionary concept, and we all have different preferences and perspectives. Imagine deciding on the best shade of blue for your living room wall among thousands of shades. Which shade of blue is the most perfect, best one?
- Investing is not a sprint, but a marathon without a defined finish line. It is a perpetual endeavour as one doesn’t control the prices in the market. Prices can change at any given point in time (rationally or irrationally), eating away years of returns.
Given these and many other difficulties, how can investors truly benefit with all the noise and debate between value, growth, quality, momentum, etc.? In other words, how does one navigate an unknown path laden with surprises around every corner? The logical answer is that we need a compass that allows us to choose the best way forward and stay the course. We mention a compass rather than a map or a GPS because it is an unknown path, one that has never been navigated before which is akin to how markets are. The future is unknown in the markets. In investing, we refer to this compass using a fancy term – investment process.
Our investment process is an extension of the investing definition explained above. We invest in businesses that exhibit a durable competitive advantage resulting in excess returns and free cash flow, and are able to do so without using excessive levels of debt. We buy businesses when they are underappreciated by the market due to what we believe is a temporary issue, resulting in us buying in at a discount to its intrinsic value (what the company is truly worth). A manifestation of this process is best exhibited by a couple of our portfolio holdings – Alphabet (Google) and Wells Fargo.
Using contemporary market definitions, one could classify Google as a growth stock and Wells Fargo as a value stock (or a value trap if the last few years of performance is considered). When we view both these stocks through the lens of our process, we believe both of them represent compelling opportunities in their own rights and deserve a place in our portfolio, irrespective of how the market labels them.
It is only human to question when things may not be working at any given point in time. This is what fuels the ongoing “Growth vs Value” debate and fosters the difference of opinions that constitute the market. In the example shared, one might argue why not invest in Alphabet only? Why hold Wells Fargo at all? Fair questions in hindsight, ones which we could answer using an analogy from sailing. Should a sailor in the middle of the ocean, without the knowledge of future, follow the compass or just sail wherever the wind is blowing the strongest at the moment? Without any guarantee of eventually reaching the shore, the odds of reaching the shore with the least amount of risk seems higher by following the compass rather than randomly changing directions with the course of the wind. That is why we own both stocks, because our process suggests so.
In the context of investing, the analogy signifies the importance of adhering to one’s investment process as it avoids unnecessary risk while simultaneously allowing one to navigate an uncertain and unknowable environment. The process allows one to stay clear of confounding labels, narratives and noise within the market.
Ultimately, it is not whether a stock is labeled value or growth that determines its returns. It is the underlying business, the growth and the returns that the business generates, and eventually the price that an investor pays that determines an investor’s returns.
These are the attributes that our investment process focuses on rather than arbitrary labels that a stock may fall into. We consistently construct our portfolios through a bottom-up process in which we are cognizant of, but are undeterred by, our deviation from the benchmark over shorter time horizons. We believe that it is this steadfast implementation, adherence and conviction in our investment process that allow us to meet our clients' objectives over their investment horizons. To conclude, in the midst of strong winds we continue to follow our compass.