Is value investing dead? Stupid question.

I’m a value investor. A proud, card-carrying one. However, I avoid using this moniker in general and in my essays, due to its confusing connotations. While I know exactly what I mean by this, you don’t. But it does bug me when I see a drumbeat of “Is value dead?”. The question itself is flawed and the methods used to answer it even more flawed.

Style boxes such as ‘value’ and ‘growth’ are nonsense.

They combine two of the dumbest ways to make sense of our messy world – formulas and labels. They shed more light on the academics who came up with them than on the topic being studied. ‘Value’ is blindly calculated as a ratio of price to earnings, sales, dividends or book value, with zero weightage given to the entity that generated these metrics. ‘Growth’ is numerically linked to progression of similar metrics, partly from an un-extrapolatable recent past and partly from notoriously unreliable future estimates. They focus on what’s quantifiable over what’s meaningful. For added joy, the two ‘labels’ are neither mutually exclusive nor collectively exhaustive. The same company can switch back and forth between the labels every few months. They are also hypothetical, as the number of real-world investors who conform to either label is exactly zero. On a personal note, while value is a critical input into my investment process and growth isn’t an input at all, the style-box approach would tag me as a ‘growth’ investor. Ouch!

To make their absurdity even starker, let’s look at the Indian context. Applying the aforementioned  ‘value’ style-box would create a portfolio comprising shareholder-unfriendly PSUs, unwieldy conglomerates, levered commodity businesses and highly levered commodity businesses with dodgy accounting (AKA banks). On a first principles basis, equity value of many of these companies is negative, making it a tad difficult to find value in them at any price. The irony of this formulaic idiocy is that what’s labelled ‘value’ is actually overpriced crap. Value may or may not be dead, but owning the value style-box portfolio isn’t a life worth living.

Whatever I’ve said about style boxes holds for other formulaic approaches that assign oversimplified labels to so-called strategies (e.g. ‘value’ index). All I’ve argued for so far is that evaluation methods are flawed. It doesn’t clarify value’s status, which is still that of Schrodinger’s cat. To attempt this in a less nonsensical manner, we have to address the question of how to think more generally about investment strategies.

Investment methods are messy, just like the world they operate in.

So, what’s a real world investment approach like? Study long history to spot broad patterns, across business and investing. A few such patterns end up as useful pointers to improving investing odds, especially when qualitative underpinnings of those patterns are decipherable. Such patterns fall way short of the fake precision of back-tests or similar gibberish. Translate these into a set of rough guidelines, partly on what to do but mostly on what not to do. Adhering to a coherent set of guidelines over a long enough period yields something resembling an investment process. This entire exercise involves heavy doses of fuzzy inputs, subjective assessments and judgment calls. There’s a lot of trial and error, especially in the early years. And there are no formulas at any stage. Reasonable people with similar skills, inputs and orientation may end up with differing approaches and portfolio. There’s also a heavy element of inconsistency over time and across situations. Even an investor with the best of intentions and discipline isn’t 100% consistent around a process, since an occasional idiosyncratic decision is inevitable. An average investor may fall well short of 100%, muddying the premise that there’s a coherent method behind an investor’s performance. A few may even confusingly claim that opportunism is a feature and not a bug in their process.

The one thing fuzzier than the investment process itself is the ability of others to figure out what that process is. Even when a large part of behaviour, portfolio and returns are available in public domain, decoding the method is essentially about reverse engineering someone else’s thought process. As with any mind-reading, transmission losses are high. Further, correlation between outcomes and process is also fuzzy, across both past and future. While I might even be able to describe my process to others, there’s no oversimplified label that can do it justice. As I am prone to self-delusion, my description may not match my behaviour. Even if I have justifiable, though biased, faith in my process, it’ll take many years to know for sure. If it doesn’t work, it’s hard to tell if the problem was with me or the process.

All of these confusingly buggy, messy aspects have to accounted for before we can (a) Figure out what approach an investor follows and (b) pass judgment on its efficacy, irrespective of what we label it as.

Value lies in the eye of the beholder

Everyone’s a value investor. No one is a value investor. Lest I sound like drunk Dickens, an explanation is in order. Judged by words, everyone is a value investor, because no one admits to the opposite. All investors claim to invest in good businesses at sensible valuations. No one claims to overpay for deadbeats run by lowlifes. However, investors end up with wildly varying actions under the garb of similar-sounding claims. Claims of value are mostly rooted in assumptions and projections, not facts. Anything can be labelled value with a forecast of sufficient duration and laxity. At the extreme, I’ve seen self-proclaimed value investors make VC investments. Value is limited by imagination, not reality.

One of the few reliable rules in the messy world is to judge based on actions than on words. Judged by actions, no one is a value investor. Certainly, not in the formulaic sense through which ‘Is value dead?” papers are written. After the passing of the exceptional Walter Schloss, I know of no investor of note or scale whose method mirrors the value style-box.

Claimants of the ‘value’ label may not actually merit it. Those who merit it may not claim it, realizing that oversimplified labels are silly. When that label is derived using hare-brained formulas, it becomes too surreal for any real investor to either claim or merit.

In the real world, investors can be judged, not strategies.

A useful idea that I have internalized over time is the notion of “unit of analysis”. In my day-job, my unit of analysis is company. I view the world one company at a time. No more, no less. Any other level of analysis is pointless, unless it has tangible implications for a specific company.

For a genuine student of investing, the unit of analysis is investor. To be more precise, an investment firm. We can study one investor at a time. No more, no less. Any higher level of abstraction is muddled up, due to the fuzziness and differences that I’ve mentioned. Any generalization into an overarching strategy that is common to a group of investors is usually misguided and erroneous.

Assuming that we have a decadal track record and some visibility into what went into it, we can judge how that investment firm has done. A part of that judgment includes a best-guess description (not label) of the firm’s approach. In a limited sense, we can judge if the approach works, or at the least, isn’t dead. There’s a crucial nuance, though. It is impossible to separate the method from its practitioner. All that we can reliably infer is that the approach worked for the people concerned. We cannot extrapolate to claim that the approach works in a general sense, for any new set of investors who sincerely attempt a similar approach.

With all this messiness in investing methods, subjectivity in defining value, wide variance across seemingly similar investors and inability to separate method from practitioner, can we even answer the “Is value dead” question? I’ll give you my answer opinion in my next essay.

[This essay is part of the series "Buggy Humans in a Messy World". Views are personal. Ideas are at best unoriginal and at worst plagiarized. For anything sensible, credit goes to people around me. For any nonsense, blame is solely mine.]