Value Investing Still Works

Stop investing in secular decliners

There’s a research paper making the rounds lately by a firm called Sparkline Capital titled “Value Investing is Short Tech Disruption.” Without nit-picking their methodology, there is certainly some truth to their conclusion that value investing has become “a massive bet against technological disruption.” That’s on value investors.

Value investing has become synonymous with failure, and the reason is that the paragons of “old school” value investing have failed. I’m not going to list firm names but you know who they are. They had a process that worked perfectly for some time, but for the wrong reasons. Unfortunately, despite their intelligence and pedigree, they haven’t adapted. Look at any of these fund’s letters and you’ll think it’s some mythical value factor working against them instead of their stock-picking skills. They likely became echo chambers, which is too common in successful firms.

The entire premise of this old school value investing was and is mean reversion: “Many shall be restored that now are fallen and many shall fall that now are in honor.” You go long the ones that will be restored and you short the ones in honor that will fall. Simple, right? Except that mean reversion doesn’t always happen when secular trends are involved, and especially so in the last twenty years. It’s not that difficult of a concept, yet many continue to invest in companies that are inarguably in secular decline at valuations that they think are “cheap.” Arguing with market valuations is in vogue with these guys. I’d argue most of value investing’s underperformance comes from buying stocks with secular headwinds, but I don’t have machine learning algorithms or a fancy paper to prove it.

But…value investing still works. Turnarounds still happen. You just have to pick the ones that actually turn, which means doing a deeper dive than saying X stock is cheap based on its 10-year average EBIT multiple or whatever. Yes, it’s much harder said than done, but you can avoid most value blow-ups by avoiding secular decliners. Old-school, purely quantitative value investing has been “dead” for a long time. Any basic screen can tell you if something is quantitatively cheap, which is why most successful “value” investments of today are probably nowhere to be found on a traditional screen.

Nonetheless, even the axiom “quantitative value investing is dead” can’t be relied upon all the time. Take something like small-cap Daseke (DSKE), the largest flatbed and specialized trucking carrier in North America. From March to mid-May, the stock was trading at < $2/share, despite having a new management team that was making huge strides in fixing its operations and divesting assets. It was very cheap on all traditional metrics, even for a TL operator. Even after adjusting for financed capex, they were generating FCF at the trough. Is it a good business? No, and it certainly earned “shitco” status for a while. But knowing what we knew back then, it was definitely going to be worth a lot more than it was trading for, given the changes happening in the business. Instead of focusing on absolute valuations, most old school firms would be better off looking for relative changes in the company’s position. What’s going to cause the valuation to change vs. “this is cheap.” This isn’t new either, as plenty of people (Mauboussin with Expectations Investing, etc.) have illuminated. Granted, no decent size hedge fund would have been able to take a meaningful position on something like this. But < $500M funds definitely could have. Point being, opportunities are always out there, even for “value investors.”