Growth vs. Value Investing

Personality psychology defines openness as a preference for variety, adventure, curiosity, and a willingness to try new things. Someone with low openness follows routines. Their day follows a pattern, and they’re comfortable mastering something they’ve done a thousand times. Is openness a desirable trait in money managers? Warren Buffet is a man of habit. He has lived in the same modest house (for a billionaire) for sixty years. He eats breakfast at the same McDonald's every morning, where, according to Bob Bryan of Business Insider, he follows a ritual: “If stocks are up, he gets a bacon, egg, and cheese biscuit. If they're down, he opts for a cheaper breakfast of two sausage patties. If the market is flat, he goes for the sausage McMuffin.” Buffet’s low openness, in my opinion, has helped his success as an investor. He doesn’t chase fads. Instead of investing with the crowd, he has remained disciplined –you could even say dogmatic– about a set of simple rules for so-called Value investing, such as: • Invest for the very long term. • Be patient and wait for opportunities (“the fat pitch”). • Look for businesses with competitive advantages, barriers to entry, or “moats.” • Only select those that have strong cash flows and dividends. • Don’t overpay for them – buy them when they’re out of favor. Low openness prevents you from wasting mental energy on missed opportunities. If you follow Buffet’s investing style, you should focus on companies you want to own based on your process. Everything else is noise. In contrast, Growth investors are well served by their high level of Openness. This style of investing requires an ability to identify new trends. These investors like to imagine what the future will look like. They look for disruptors rather than disrupted companies. Think social media vs. newspapers, electric vs. gasoline cars, and ride-sharing companies vs. yellow taxis. Amazon, Netflix, Google, and Tesla are all growth companies. Growth portfolio managers want to be on the right side of change. Some companies that Growth portfolio managers own don’t pass the “Buffet test” for cash flows and dividends. But they can be excellent investments. To identify them, portfolio managers must be open-minded and imaginative. Which is the superior style of investing, the lower-openness Value style (a la Buffet) or the higher-openness Growth style? Both. I believe it depends on the portfolio manager’s personality and skills. Value and Growth investing are different games. And “Core” or diversified investors must be flexible between Value and Growth, depending on the conditions and opportunities. These managers are the biathletes of the investment world. References: Goldberg L. R. (1993). The structure of phenotypic personality traits. Am Psychol. 48(1): 26-34. Bryan, B. (2022, April 30). I ate like Warren Buffett for a week - and it was miserable. Business Insider. #psychology #investing

This got me thinking. Value investing has had a rough 20 years in the U.S. But the story is different outside the U.S. Here's what you need to know: → U.S. Performance: The Russell 1000 Value has returned 15.4% this year, while the Russell 1000 Growth has returned 24.1%. Over the past 20 years, value stocks in the U.S. have underperformed growth stocks by an average of 0.9%. → Historical Context: We are in the longest period on record where value has underperformed growth. However, there have been times when other premiums also experienced long periods of underperformance. For example, U.S. stocks have underperformed U.S. Treasury bills in three separate periods longer than 12 years. Despite this, U.S. stocks have outperformed Treasury bills by 8.7% on average from 1927 to 2023. → International Performance: In developed markets outside the U.S., the value premium has averaged 2.7% over the last 20 years. In emerging markets, it has averaged 7.5%. Any theory suggesting that value investing is "broken" must explain why it has performed well outside the U.S. → Valuation Changes: One major factor for the outperformance of growth stocks in the U.S. has been changes in valuations. Growth stocks have become more expensive based on various metrics like book value, earnings, cash flow, or sales. This has boosted their performance. Valuations are the best predictor we have of future returns. Currently, value stocks are very inexpensive compared to historical averages, suggesting their future returns may be above average. → Future Outlook: It is possible that growth stocks will continue to get more expensive or outperform expectations. However, making investment decisions based on past performance, especially when value stocks are extremely cheap compared to growth stocks, is not advisable. Stay informed and make wise investment choices.