Download Are Growth and Value Dead?

Are Growth and Value Dead?
Lawrence S. Speidell, Partner
Nicholas Applegate
Someone once said: “Nowhere is value so perfectly calibrated with price as in cigars”. Unfortunately,
stocks are not cigars; and as a result, investors have searched for years to identify the perfect clue to value,
and thus to future performance. The search for value in stocks has led to elaborate frameworks for the
valuation of investments as well as elaborate frameworks for the evaluation of the styles of investment
managers themselves. In light of recent market volatility, these frameworks may deserve some reexamination.
1999 was the sixth consecutive year in which the S&P BARRA Growth Index outperformed the Value
Index. Some investors have questioned whether Value will ever again be a successful investment approach.
Some of them believe this is a “New Era” in which technology stocks are revolutionizing the way business
is done: “New Economy” stocks will survive while “Old Economy” stocks (mostly Value stocks) will
become extinct. Other investors say that growth stocks are mostly driven by a technology stock bubble
which is bursting and will lead to a return of classic fundamental analysis, favoring value stocks. Then
there are observers who believe that the debate is defined too narrowly. They say that “Traditional” or
“Deep” Value is too rigid a definition, whereas the concept of “Flexible” Value will better cope with the
opportunities changing the world. Finally, there are observers who question the whole Value/Growth
framework, which has been used widely since Callan is believed to have established it in the mid-1970s.
Some of these critics say that Growth is not the opposite of Value; it is the creator of Value – without
understanding potential for growth, one cannot correctly identify value….
History
Value investing (in fact all professional investing) traces its roots to Graham and Dodd’s classic book
Security Analysis, first published in 1934. At the depths of the Depression, they stressed the importance of
fundamental analysis and the use of financial statement data to compare stocks. Over the last 30 years,
practitioners have applied the term “Graham and Dodd” research to describe value investing as opposed to
growth investing, but the authors did not make that distinction. Their discussion of sound investment value
included assessing the “favorable possibilities for future growth”.
With the rise of institutional investing in the 1960’s and 1970’s, however, the practice of dividing security
analysis was divided into two basic camps, value and growth investing. Consultants, especially at Callan
Associates, adopted these styles as two opposite poles and built them into today’s framework of portfolio
diversification.
Academic researchers have explored the characteristics of the value and growth styles, and they have often
concluded that value stocks can be defined as stocks with a low price/book ratio, while growth stocks tend
to have a high ratio. They have further suggested that value stocks (so defined) tend to outperform the socalled growth or “glamour” stocks. Numerous papers discuss this topic, including Fama and French [1993].
Dave Umstead and Lyle Davis [1995], Josef Lakonishok [1994], Barton Biggs [1995] and Bill Sharp
[1993]. Ibbotson Associates published a chapter in their Yearbook 2000, which concluded that from 1927
to 1999, value stocks had returned 13.4% per year whereas growth stocks had returned only 10.2%. By the
mid-1990’s many academic papers stated flatly that “Value outperforms Growth”, and some institutional
investors responded by terminating their growth managers or at least tilting their asset allocation in favor of
value. Unfortunately, many of these moves came at precisely the wrong time, as shown in the chart below.
Figure 1
S&P/Barra Value Index vs. Growth Index
20.00
10.00
5.00
-10.00
-15.00
-20.00
-25.00
As shown in Figure 1, from 1975 to 1993, Value outperformed in 11 out of 19 years. From 1993 on,
however, value has not outperformed at all. At the end of 1999, the firm of AXA Rosenberg found that
their measure of growth stocks outperformed value stocks by 125% over the prior 18 months, representing
a 6.8 standard deviation event, which “should occur only once every 285 billion years”.
Benchmarks
Part of the issue of Growth versus Value lies in the validity of the benchmarks we are using to describe
these disciplines. Most index providers use similar methodologies, but there are differences as shown in
Table 1 below. While BARRA, Russell, Wilshire and MSCI rely heavily on Price/Book as a discriminator,
Russell also uses Estimated Growth, Wilshire and Prudential use Earnings to Price and Salomon used three
growth and four value measures.
Table 1
Value/Growth Index
Methodology:
Book to Price
Est 5 yr Growth Earnings to Price
(IBES)
(on IBES 1 yr est)
S&P/BARRA
Yes
No
No
Half market cap in each index
Reconstituted 1/1 & 7/1
Russell U.S.
Yes
Yes
No
70% of stocks are Growth or Value
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
-5.00
1977
0.00
1975
Value Return % less Growth Return %
15.00
Russell non-U.S.
country
30% of stocks partly in both
Reconstituted 6/30
PB, P/Cash Flow, PE, IBES 5yr est growth equal weighted scores within
Stocks are either growth or value
MSCI
Yes
No
No
Wilshire
Yes
No
Yes
Salomon
Prudential
Score = 75% B/P + 25% E/P
Half market cap in each index
Reconstituted in June
Growth Stocks have high: 5 yr EPS, Sales Growth
Retained ROE
Value Stocks have high: B/P, Cash Flow/P, Sales/P, Yield
Roughly 25% of names and 50% of Cap is all Growth or Value, remainder are
probability weighted in both indexes
Growth Stocks have:
Value Stocks have:
Sales growth > 10%
IBES Est 5 yr Growth > Median
Low Dividend Payout
Low Debt/Capital
Earnings/Price > Median
Dividends constant or rising
Thus, the benchmarks are different, but most of them rely heavily on Book to Price. While simple, this
approach may not be relevant. All the style indexes, however, ignore the real complexity of money
management. Value investors do more than seek simple cheapness as measured by BP or EP, and growth
investors don’t just look for expensive stocks. Oversimplification of the definitions of Growth and Value
can cause unreasonable distortions of the asset allocations of institutional investors.
Fundamentals
A study by Chicago Investment Analytics, Spring 2000, looked at the underperformance of Value stocks
and measured fundamental differences between Value and Growth (based on Earnings/Price) in the top
1000 stocks going back to the mid-1980s. They found, for example, that value stocks have generally had
estimated future growth rates of 10%, whereas for growth stocks the estimated growth rate has recently
accelerated from 20% to 29%. Similar relative improvements on the part of growth stocks were also found
in Sales Growth (see Table 1), Earnings Surprises and Estimate Revisions.
Table 1
5 Year Estimated EPS Growth
Annual Sales Growth
Positive Earnings Surprises
% upward EPS Revisions
Value
Historically
10%
6-7%
53%
45%
Value
Now
Same
Same
Same
42%
Growth
Historically
20%
15%
54%
43%
Growth
Now
29%
29%
70%
58%
While the market may have overreacted, nevertheless, there have been fundamental improvements behind
the recent out-performance of Growth versus Value.
What do we mean by “value”?
One problem is with Value investing is this word “Value”. When we use the term value in our daily lives,
we generally mean it as a measure of quality relative to price, (or quality per dollar: Value = Quality / $).
Price itself determines whether a coat or a car is cheap or expensive, but price does not determine whether
it is a good value. One can trade off price and quality in the same way we do Risk and Return in the
Efficient Frontier of investing. Thus, we can think in terms of a Quality Frontier for every product we buy:
If we pay a little more, we should get something that is better quality. In an ideal world, value would be
perfectly calibrated to price, as in the opening quote about cigars. However, in most areas of the economy,
the quality frontier is not a straight line, but rather an upward sloping curve which reflects diminishing
returns in quality as the price goes higher. (A Cadillac is a little better than a Chevrolet, but a Chevrolet is a
lot better than walking).
While the slope of a quality curve flattens at higher prices, the behavior of our preferences is just the
opposite. For each person, we can construct Utility Functions which are curves of equal value. We make a
purchase when our Utility Function touches the Quality Frontier. The shape of our Utility Function will
change on days when we feel richer or poorer, but often we may find the value of two products (a Ford and
a Mercedes) to be similar even though one is expensive and the other cheap. Thus the Value of a product is
not its price or cheapness, but rather its Quality compared to its Price (V = Q/P).
Figure 3
V alue Fram ew ork
U tility Functions
Quality
Q uality Frontier
B uy P oint
P rice
In the world of investing, however, Value is commonly represented as the amount of Earnings, Dividends
or Book Value per dollar of Price. When some investors talk about “value” stocks, they are simply talking
about cheap stocks. They are saying nothing about the quality of those stocks. In fact, Growth is not the
opposite of Value, any more than growth investors set out to buy stocks that are bad values.
Today, most institutional investors behave in very similar ways: They all get the same news feeds,
databases and street research, and they all cover most aspects of classical Graham & Dodd research. Real
information advantages are scarce (particularly given the SEC’s rules on non-public information). Thus,
differences among investment firms are more in where they focus the emphasis of their work rather than
what they leave out completely. They all build portfolios based on the same basic steps: Acquisition of
information, the estimation of future streams of earnings, dividends and cash flows, the estimation of asset
values and the estimation of risk. These results are then compared with a stock price to reach a buy, sell or
hold decision. A “laundry” list of analytical tools and activities is shown in Table 2, below. Value mangers
are likely to focus more on those at the top of the list; while growth managers spend more time on those at
the bottom.
Table 2
Accounting Measures
Earnings
Dividends
Cash Flow
Book Value
Asset and Liability Valuation
Accounting analysis
Valuation Models
Discount Models: Discount rates, fade rates, sustainable growth rates
Fade Rates
Enterprise Value Added, cost of capital
Cash Flow Return on Investment, replacement cost, present value of Plant & Equipment
Price Targets
GARP, PE versus Growth Rate
Subjective Fundamental Measures
Management Quality
Alliances
Research & Development
New Products
Strategy
Growth Measures
Earnings Growth
Sales Growth
Cash Flow Growth
Retained Return on Equity
Change Measures
Estimate Revisions
Earnings Surprises
Fundamental Catalysts
Price Momentum
Evolution of the Economy
The stock market and the economy have changed greatly since Graham and Dodd wrote Security Analysis
in 1934. At that time, many stocks were depressed below their liquidation value. Some even had liquid
assets in excess of their market capitalizations. By the 1960s most of these values had disappeared, but
America still dominated many capital-intensive industries. And as a result, many stocks with low
Price/Book did well. In the late 1970s, our competitive economic position had eroded, but many basic
industry stocks benefited from the inflationary global boom in commodity prices. Then in the late 1980s
many industrial stocks benefited from aggressive restructurings, which improved margins and unlocked
values.
Today, however, many easy gains from security analysis have been realized. The stock market is more
efficient. Also, unfortunately, the global competitive outlook for companies in many traditional U.S.
industries is not good. More than ten years ago, management consultant Peter Drucker predicted the rise of
new Knowledge-based companies to replace the dominance of the old, mature Production and
Manufacturing-based companies in our economy. This forecast has come true. There has been enormous
vitality and innovation in Knowledge-based companies in technology, health care and financial services.
This has produced strong job growth in the U.S., although many jobs in the Old Economy” sectors of
manufacturing and production have disappeared. Today, the economic position of the U.S. is strong
globally, not because we have protected our Old Economy companies, but because we have stimulated the
New Economy companies.
Unfortunately, this evolution in economic leadership has presented challenges to investors. One challenge
is that historical cost accounting may be less reliable for comparing values today because it treats New
Economy and Old Economy companies unevenly. In the Old Economy, hard assets iof manufacturing and
production companies have had measurable useful lives for depreciation purposes, often specified by tax
codes. Today, however, those lives can be shortened unpredictably by technological obsolescence. This
can cause Old Economy companies to overstate their assets, book values and earnings. Meanwhile the
assets of Knowledge-based companies in the New Economy have assets which may be understated,
because they are hard to quantify from an accounting standpoint. Innovations, patents, goodwill, R&D,
brand, employees and market share are all unrecognized or understated under GAAP accounting. Because
of these distortions, accounting data has lost some of its power in identifying stock market values.
Another challenge comes from the intense competitive dynamics of many New Economy industries.
Michael Price (XXXXXrefrenceXXX) in the Gorilla Game described this as a “winner take all”
environment. It is driven by the economics of products where development costs are high but production
costs are low, as in computer software. In these types of businesses, the goal is to gain a monopoly by
lowering prices to discourage competitors while gaining enough volume to offset the initial costs.
Companies that can gain an edge in market share can then drive out the competition, as VHS videorecorders did with Betamax. Treasury Secretary Larry Summers describes this an “accelerator” economic
model (where higher production volume lowers production costs, encouraging lower prices, which increase
demand and lead to still higher production volume). This can be contrasted with the “thermostat” model of
the Old Economy (where higher production volume meets capacity limitations, increasing costs and thus
reducing customer demand). In a “winner take all” environment, the law of “regression to the mean” does
not work. Companies which are losers will always look like great values, while their fundamentals
continue to deteriorate. Jack Welsh at GE pioneered the strategy of leadership in every business., and in the
competitive New Economy, this is a fundamental strategy. In the New Economy, response to change is
crucial, and history is a poor guide to the future. Just because a stock or industry is selling at a new all-time
low valuation on Book to Price does not mean that it will revert to its historic valuation.
Evolution of Investment Styles
In this changed environment, investors have responded with new approaches to valuation, often pioneered
by new “maverick” firms. With success, some of these disciplines have been copied and incorporated into
the mainstream. The result has been a multiplicity of investment styles that goes far beyond the original
simple framework of Value versus Growth. It is time to think of a new landscape of investment styles,
which can encompass new developments in valuation techniques and can recognize that “value” can be
found in many ways and in many places in the market.
What really separates investors is not a difference in their commitment to finding good values; it is
differences in their willingness to look out into the future, to accept growth. If they are doubters, they will
be skeptical about future growth. The time horizons of their analysis will be short, and they will focus more
on current earnings and assets. They will spend less time assessing the impact or the likelihood of long
term growth. As a result, their portfolios will have stocks with lower growth rates, where the payback for
investing is more immediate. Other investors, however, are more willing to believe in forecasts. They look
forward over long time horizons, and they have more confidence in their ability to identify the potential of
a company’s products in the future. These investors will own companies with higher future growth rates.
Therefore, in constructing a framework for discussing and comparing investment styles, we can use a scale
based on the growth rates of stocks in managers’ portfolios, from low to high. This reflects the time
horizon managers use in their analysis, but is easier to measure. For this scale of growth, we can use IBES
Estimated 5 year growth, possibly combined with historical sales growth (already Russell uses IBES
Estimated 5 year Growth as one of its measures, and Prudential uses both IBES Estimated 5 year Growth
and historic sales growth). In addition to this horizontal growth scale, however, we suggest measuring
managers on a vertical axis scale which would capture the trend of recent positive and negative changes in
fundamentals. The resulting framework is presented in the Style Map below:
Figure 4
This Style Map has several features:
1) On the horizontal “Growth Axis”, Low Growth/Short Horizon and High Growth/Long Horizon are the
extremes, capturing the relative optimism or skepticism of investors about the future. Over time, the
median of the population of investors will shift to the right or left depending on the stability of the outlook
(in 1999, it shifted to the right with a vengeance; but five years ago, due to the Fama and French paper
endorsing “value” stocks, median manager probably moved toward the left).
2) On the vertical “Trend Axis”, Positive Change and Negative Change identify investors who tend toward
being either trend followers or contrarians. Generally, however, only retail investors and a few quantitative
investors would be at the upper or lower extremes of Momentum or Contrarian Styles. At these extremes,
analysis is primarily Technical rather than Fundamental. Thus, the Ellipse is drawn to define the limits of
Fundamental Analysis, with pure Technical Analysis roaming beyond its frontier.
4) Analytical Tools are shown in Red:
1) Yield is the province of Deep Value investors. It drives portfolios into low growth stocks and
often stocks which have become particularly cheap because of negative fundamental changes (the
highest yields often come just before dividend cuts).
2) Book to Price and Earnings to Price are used most heavily by the index providers and academics.
Lately, however, they have developed several accounting pitfalls mentioned above. Rapidly
growing companies are often penalized by write-offs of advertising, R&D and goodwill; while
slower growing capital intensive companies may not be writing off assets quickly enough, leading
to understatement of their depreciation and overstatement of their book values. As the U.S.
economy moves from a production base to a knowledge base, these distortions have widened the
gap in accounting between traditional value and growth stocks.
3) EV/EBITDA (Enterprise Value / Earnings Before Interest, Taxes and Depreciation) has grown in
popularity recently. Because it adds debt and equity together, enterprise value is less sensitive to
negative relative price strength than B/P or E/P, but the addition of interest and depreciation to
pretax earnings causes a bias in favor of capital-intensive companies.
4) Fundamental Catalysts have been sought for many years by value managers in order to avoid
buying declining stocks too early. Now catalysts are widely discussed all investors as early buy
signals.
5) DDM, CFROI and EVA are quantitative valuation models which have been widely adopted.
While often conceptually accurate, they suffer in practice from estimation difficulties. Discount
models, for example, are extremely sensitive to estimates of the duration of growth, the fade rate
of growth, the terminal growth rate and the discount rate.
6) Earnings Surprises and Estimate Revisions are powerful indicators of positive change. The power
of Estimate Revisions has been confirmed by studies in behavioral finance, which have found that
analysts tend to “anchor” their estimates to their previous number and thus under-react to new
information. This effect is likely to continue to be important. Earnings Surprises, however, may
lose some of their power as they fall victim to the game between managements and analysts over
quarterly estimates. While companies talk down their expectations so they can report a positive
surprise, analysts have begun to withhold their best estimates from published databases so they
can tell their favored clients their higher “whisper” number. Recently, the market has become
more volatile as the SEC’s Fair Disclosure rule has prompted companies to reduce the flow of
information.
5) Investment Styles are shown in Blue Italics:
a. Deep Value, Absolute Value, Traditional Value and Yield-Based Value are the oldest
value styles, which rely on relatively short forecasting horizons. They have been
challenged in the recently volatile market..
b. Flexible Value and Relative Value are more moderate styles, which have performed
somewhat better then Deep Value. They may seek bargains across industries and sectors
or they may seek companies which are historically cheap. This approach may
underestimate the importance of leadership in some industries.
c. E) GARP (Growth at a Reasonable Price), is shown as a diagonal line moving down to
the right. This style can buy stocks across a broad range of growth rates, but among
higher growth rate stocks, it typically looks for cheapness. Unfortunately, some of these
stocks are cheap for a reason….they are suffering negative change.
d. F) Traditional Growth and Earnings Momentum Growth are on the right, differing in the
degree of their interest in positive change.
Investors have been successful at recognizing when old valuation tools are no longer useful and developing
new tools to gain an edge over the “efficient” market. It is time to develop new tools as well for looking at
investors and for understanding the differences in their styles. The traditional yardstick of Value versus
Growth has always been flawed by the fact that growth is not the opposite of value, but rather an important
element in it. Value and Growth are not dead, but the Style Map provides an opportunity to measure
mangers more precisely, by the tools and the time horizons they use rather than by backward-looking
accounting measures. Successful investors will lie in all quadrants of the Style Map. There is room in
institutional investing for investors who seek strong or weak current trends and who seek high or low
growth, using long or short horizons.
REFERENCES
Barton M. Biggs, “Value will out” Morgan Stanley Strategy and Economics, April 10, 1995
Carlo Capaul, Ian Rowley and William F. Sharpe, “International Value and Growth Stock Returns”
Financial Analysts Journal, January-February 1993
W. Scott Bauman, C. Mitchell Conover and Robert E. Miller, “Growth versus Value and Large-Cap
versus Small-Cap Stocks in International Markets”, Financial Analysts Journal, March/April 1998
Eugene F. Fama and Kenneth R. French, “Common Risk Factors in the Returns on Stocks and Bonds”,
Journal of Financial Economics, 33, 1993
Benjamin Graham, David L. Dodd and Sidney Cottle, Security Analysis, New York: McGraw-Hill, Fourth
Edition, 1962
Robert A. Haugen, “The Race Between Value and Growth”, The Journal of Investing, Spring 1997
J. Lakonishok, A. Shleifer, and R. Vishny, “Contrarian Investment, Extrapolation, and Risk.” Journal of
Finance December 1994
Richard O. Michaud, “Is Value Multidimensional? Implications for Style Management and Global Stock
Selection” Journal of Investing 1997
Ernesto Ramos & Lawrence Speidell, “Do Estimate Revisions Work in International Markets”, The Journal
of Investing, Spring 1998
Dennis Trittin, “Value Tilts - Why the Free Lunch and the Active Manager Enigma?”, Russell Research
Commentary, November 1994
David A. Umstead, “International Equity Style Management”, Equity Style Management, Chicago: Irwin
Professional Publishing, 1995
Richard S. Yeh and Yazid M. Sharaiha, “Global Style Investing with MSCI Value and Growth Indices”,
Global Equity and Derivative Markets, Morgan Stanley Dean Witter, December 1997
Robert D. Barkley, of Barrow, Hanley, Mewhinney & Strauss Inc., “Style allocation drift”, Pensions &
Investments, April 17, 2000
Robert J. Pelosky and Hernando Cortina, Morgan Stanley, Global Strategy, MacroMorphosis, March 22,
2000
Peter Drucker, “Putting more now into knowledge”, Forbes Magazine, May 15, 2000
Lawrence S. Speidell
Nicholas-Applegate Capital Management
[email protected]
Have we miss-specified the Style
Map….
Are Value and Growth
Dead?
The Markets…
Have Been Volatile
Value Has Been Under Siege….
Growth Has Been Under Siege….
Value Is Now Back on Top….
Large Growth
R1000G
Small Growth
R2000G
Large Value
R1000V
Small Value
R2000V
Investment Styles:
The Traditional Framework
R1000V = 2838.7
R1000G = 3091.9
4 5
8 9
9 0
4 5
8
8
9 0
1 2
3
6 7
1 2
6 7
3
-7 c-7 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-9 c-9 c-9 c-9 c-9 c-9 c-9 c-9 c-9 c-9
c
e e
e e
e e
e e
e e
e e
e e
e e
e
e e
e
e
e
D D D D D D D D D D D D D D D D D D D D D D
100
1000
10000
Russell 1000 Growth vs Value
Value and Growth are Close after 20
years
Value Return % less Growth Return %
--22 55 .0
.0 00
--22 00 .0
.0 00
--11 55 .0
.0 00
--11 00 .0
.0 00
--55 .0
.0 00
00 .0
.0 00
55 .0
.0 00
11 00 .0
.0 00
11 55 .0
.0 00
22 00 .0
.0 00
S & P /B a r r a V a lu e I n d e x v s . G r o w t h I n d e x
1983
1981
1979
1977
Source: Chicago Investment Analytics
1993
1975
1975-1993: 11/19 1994-1999: 0/6
1997
1995
But Value had a Losing Season:
1999
1991
1989
1987
1985
D
9
-7
c
e
-30
-20
-10
0
10
20
30
ce
D
81
D
3
-8
c
e
D
5
-8
c
e
D
7
-8
c
e
D
9
-8
c
e
ce
D
91
D
3
-9
c
e
D
5
-9
c
e
S&P/Barra Value Index vs. Growth Index
D
7
-9
c
e
Will there be Mean Reversion?
…or Mean
Aversion?
Value Return % lass Growth Return % (12 mos)
D
9
-9
c
e
Growth Stocks have High: 5yr EPS, Sales, RROE
Value Stocks have High: B/P, CF/P, Sales/P, Yield
Growth Stocks: Sales growth > 10%
IBES Est 5 yr Growth > Median
Low Dividend Payout, Debt/Capital
Value Stocks: Earnings/Price > Median
Dividends constant or rising
Prudential
Yes
No
Salomon
No
No
Yes
Yes
Yes
Yes
Est 5 yr Growth Earnings to Price
(IBES)
(on IBES 1 yr est)
No
No
Yes
No
Wilshire
MSCI
S&P/BARRA
Russell
Book to Price
What is Value?
Source: Chicago Investment Analytics
5 Year Est EPS Growth
Annual Sales Growth
Positive Earnings Surprises
% upward EPS Revisions
Value
Growth
80-95 Now 80-95 Now
10% Same 20% 29%
6-7% Same 15% 29%
53% Same 54% 70%
45% 42% 43% 58%
Has Value Changed?
1Y Reported Sales Gth %
-1 0 .0 0
-5 .0 0
0 .0 0
5 .0 0
1 0 .0 0
1 5 .0 0
2 0 .0 0
2 5 .0 0
3 0 .0 0
3 5 .0 0
H i g h E/P
Source: Chicago Investment Analytics
Figu re 12: 1Y S ale s Growth C om paris on
Has Value Changed?
12/31/1982
09/30/1983
06/30/1984
03/31/1985
12/31/1985
09/30/1986
06/30/1987
03/31/1988
12/31/1988
09/30/1989
06/30/1990
03/31/1991
12/31/1991
09/30/1992
Lo w E/P
06/30/1993
03/31/1994
12/31/1994
09/30/1995
06/30/1996
03/31/1997
12/31/1997
09/30/1998
06/30/1999
10
100
100
200
300
1000
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 20
00
S&P 500
P r o f it s
I n f la t io n A d ju s t e d N a t io n a l In c o m e a n d P r o d u c t A c c o u n t s
C a p it a liz e d b y Q u a r t e r ly A v e r a g e 1 0 - Y e a r B o n d Y ie ld
In d e x o f E c o n o m ic P r o f it s v s . S & P 5 0 0
What is Value?
Price Follows
Earnings
Index, Q1 1991 = 100
-40
-30
-20
-10
0
10
20
30
-20
-10
Five Year Historical Earnings Growth
40
50
60
Japan
10
0
EAFE ex Japan
United States
20
30
40
Decile Median Five Year Historical Earnings Growth
and Five Year Annual Return
1997
What is Value?
Price Change Follows Earnings
Growth
Five Year Annual Return
0
5
10
15
20
-50
0
25
50
Five Year Historical Earnings Growth
-25
75
EAFE ex Japan
Japan
United States
Decile Median Five Year Historical Earnings Growth
and Long Term Growth Estimate
1997
What is NOT Value….
Growth Estimates Follow Historical
Earnings
Long Term Growth
Estimate
0
1
2
3
4
-50
0
25
50
Japan
EAFE ex Japan
United States
Five Year Historical Earnings Growth
-25
1997
Decile Median Five Year Historical Earnings Growth
and Price to Book Ratio
75
What is NOT Value…
Price to Book Follows Historical
Earnings
Price to Book Ratio
0
1
2
3
4
5
6
0
20
30
EAFE ex Japan
Japan
United States
Estimated Long Term Growth
10
1997
40
Decile Median Estimated Long Term Growth
and Price to Book Ratio
What is NOT Value or Growth…
High Price to Book Sometimes Has High Est
Growth
Price to Book Ratio
What is NOT Value or Growth…
High Price to Book Sometimes Has High Est
Growth
0%
25%
50%
75%
100%
5.2
US
3.0
Japan
2.1
EAFE
ex
Japan
PB Ratio
Technology & Health Services
Commercial Services
Consumer, Retail & Finance
Transport, Energy & Utilities
Manufacturing
Top Decile of Companies
by Long Term Growth Estimate, 1997
What is NOT Growth or Value…
High Price to Book is Sometimes High Est
Growth
Percent in Sector
-15
-10
-5
0
5
10
15
20
1
2
3
5
6
7
Price to Book Decile
4
8
Japan - 5 Year, 1 Year
US - 5 Year, 1 Year
EAFE ex Japan - 5 Year, 1 Year
9
Price to Book Decile versus
One and Five Year Actual Earnings Growth
1985-1992
10
What is NOT Growth…
Price to Book Does Not Predict Earnings
Growth
Actual Earnings Growth
-25
0
-5
-10
-15
-20
25
20
15
10
5
1
2
4
5
6
7
8
Estimated Long Term Growth Decile
3
Japan - 5 Year, 1 Year
US - 5 Year, 1 Year
EAFE ex Japan - 5 Year, 1 Year
1985-1992
9
Estimated Long Term Growth Decile versus
One and Five Year Actual Earnings Growth
10
What is NOT Growth…
LTG Estimates Do Not Predict Earnings
Growth
Actual Earnings Growth
Quality
Price
2000
1970
Q uality Frontiers
Value Fram ew ork
What is Value?
Quality
U tility Functions
Price
B uy P oint
Q uality Frontier
Value Fram ew ork
Value = Quality / Price
Management
Accounting
Market Risk
Specific Risk
Transparency
Visibility
Growth
What is Investment Quality?
ƒ Matching Costs with Revenues
ƒ R&D
ƒ Advertising
ƒ Goodwill
ƒ New Economy
ƒ Obsolescence
ƒ Asset Values
ƒ Depreciation Rates
ƒ Old Economy
Quality Issues in Accounting
ƒ
ƒ Winner Takes All
ƒ Losers will always look like Great
Values
ƒ Returns revert to the extreme
Game)
Geoffrey Moore’s Theorum (Gorilla
Quality Issues in Corporate
Strategy
ƒ Start-up Cost: $100,000
ƒ Unit Cost: $1,000 – falling, then rising
ƒ New Economy – “Positive Feedback”
ƒ Start-up Cost: $1 Mil
ƒ Unit Cost: $1 - constant
ƒ Old Economy – “Negative
Feedback”
Larry Summers: “Thermostat versus Avalanche”
Quality Issues in Corporate
Strategy
Costs
1
10
100
1000
10000
100000
1000000
10000000
100000000
1000000000
0
25
50
75
Old Economy
Cost/Unit = $1,000+
Units
100
125
150
175
Old Avg Cost/Unit
Old Economy Total Costs
Old Economy: Rising Volume = Rising Prices = Lower Demand
Larry Summers: “Thermostat versus Avalanche”
Quality Issues in Corporate
Strategy
Costs
1
10
100
1,000
10,000
100,000
1,000,000
10,000,000
100,000,000
1,000,000,000
0
25
50
75
New Cost/Unit = $1
Old Cost/Unit =
$1,000+
New Total Costs
Units
100
125
150
175
Old Avg Cost/Unit
New Avg Cost/Unit
Old Total Costs
New Economy: Monopolies may be OK….
Larry Summers: “Thermostat versus Avalanche”
Quality Issues in Corporate
Strategy
Source: Morgan Stanley
Information overload
Accelerated discounting
Thin is in
Real-time forecasting
Future without history
Collaboration/alliances
Global standards
One world sector selection
1999 - future
Pre-1999
Information scarcity value
Lengthy gestation
More is better
Long-term forecasting
History leads the future
Proprietary work
Disparate disclosure
Country/region allocation
New Economy
Old Economy
Quality Issues in Corporate
Strategy
Source: Morgan Stanley
Information overload
Accelerated discounting
Thin is in
Real-time forecasting
Future without history
Collaboration/alliances
Global standards
One world sector selection
1999 - future
Pre-1999
Information scarcity value
Lengthy gestation
More is better
Long-term forecasting
History leads the future
Proprietary work
Disparate disclosure
Country/region allocation
New Economy
Old Economy
Quality Issues in Corporate
Strategy
Regression to the Mean…Unreliable
Historical Accounting… Less Valuable
High and Low Growth… OK
Response to Change… Crucial
Quality Issues in Corporate
Strategy
Traditional Value
Low Growth
High Growth
Traditional, Consistent Growth
Landscape of Style:
High Growth and Low
Traditional Value
Low Growth
Short Horizon
High Growth
Long Horizon
Traditional, Consistent Growth
Landscape of Style:
Growth & Time
Technical Analysis
Traditional Value
Low Growth
Short Horizon
Technical Analysis
Negative Change
Contrarian
Momentum
Positive Change
Technical Analysis
High Growth
Long Horizon
Traditional, Consistent Growth
Technical Analysis
Landscape of Style:
Growth & Change
EV/EBITDA
PE Based
EP BP
Yield
Technical Analysis
Deep Value
Traditional Value
Low Growth
Short Horizon
Technical Analysis
Negative Change
Contrarian
Fundamental Catalysts
DDM, CFROI, EVA, RROE
Earnings Surprises
Estimate Revisions
Momentum
Positive Change
Technical Analysis
High Growth
Long Horizon
Traditional, Consistent Growth
Technical Analysis
Landscape of Style:
Tools of the Trade
Yield
Technical Analysis
Deep Value
Technical Analysis
Relative Value
Fundamental Catalysts
DDM, CFROI, EVA, RROE
Negative Change
Contrarian
GARP
Technical Analysis
High Growth
Long Horizon
Traditional, Consistent Growth
Earnings Momentum Growth
Earnings Surprises
Estimate Revisions
Momentum
Flexible Value
GARP
PE Based
EP BP
EV/EBITDA
Traditional Value
Low Growth
Short Horizon
Technical Analysis
Positive Change
Landscape of Style:
A Mosaic of Managers
Landscape of Style:
Recent Results
Value & Growth are Not Dead…they are the
same!
High and Low Growth… OK
Response to Change… Crucial
Regression to the Mean…Unreliable
Historical Accounting… Less Valuable
Conclusions
Yield
Technical Analysis
Deep Value
Technical Analysis
Relative Value
Fundamental Catalysts
DDM, CFROI, EVA, RROE
Negative Change
Contrarian
GARP
Technical Analysis
High Growth
Long Horizon
Traditional, Consistent Growth
Earnings Momentum Growth
Earnings Surprises
Estimate Revisions
Momentum
Flexible Value
GARP
PE Based
EP BP
EV/EBITDA
Traditional Value
Low Growth
Short Horizon
Technical Analysis
Positive Change
Landscape of Style:
A Mosaic of Managers