The Enduring Power of Value Investing: A 97-Year Retrospective

At Hoover Capital Management (HCM), we’ve always championed the principles of value investing. Our commitment is rooted in the belief that focusing on fundamentally strong companies with undervalued assets leads to sustainable long-term growth. This belief is further reinforced by a recent analysis of the French High Minus Low (HML) factor, which highlights the historical performance of value versus growth stocks, as shown below:

The data, spanning an impressive 97 years from July 1926 to December 2023, presents a compelling case for value investing. The cumulative return of value stocks has eclipsed that of growth stocks by an astounding 3,000%. To put it into perspective, value investing has delivered 30 times the return of growth investing over this period.

This remarkable outperformance underscores the resilience and potential of value investing. It serves as a reminder that while market trends may fluctuate, the fundamentals of value investing remain a cornerstone for building wealth. As we navigate the complexities of today’s global markets, the lessons from the past century continue to guide our investment strategy at HCM.

We believe that this historical perspective reinforces our commitment to value investing. It highlights the importance of patience, discipline, and a focus on fundamentals in achieving long-term investment success. As always, we remain dedicated to helping our clients unlock global investment opportunities through a disciplined and informed approach to value investing.

Unveiling the Influence: The Magnificent 7 Shaping

A Return to Dominance: The Magnificent 7’s Influence in 2023

In 2023, the financial markets witnessed a striking phenomenon. The S&P 500 and MSCI ACWI reported robust returns of 26.2% and 22.2%, respectively, signaling a buoyant year for investors. However, these headline figures mask a deeper, more intricate narrative of market concentration and disparity.

The Disparity Behind the Headlines

While the market-weighted S&P 500 and MSCI ACWI indices soared, their equal-weighted counterparts told a different story, lagging with returns of 14.0% and 10.2%. This divergence underscores the significant impact of market-weighted movements, where a handful of dominant stocks disproportionately influence overall index performance.

The Rise of the Magnificent 7

Central to this narrative is a group of technology and growth-oriented stocks, aptly dubbed the Magnificent 7 — Apple, Microsoft, Amazon, Nvidia, Google, Tesla, and Meta. These titans not only dominated the market but also accounted for a staggering 62% of the S&P 500’s annual return. Their dominance favored stocks with high valuation metrics, such as price-to-earnings (P/E), price-to-sales, and price-to-book ratios, while traditionally value-based stocks lagged behind.

The Shift in Market Dynamics

Our 2023 market outlook speculated a shift away from the hegemony of American mega-cap/tech companies. However, 2023 saw these very entities, particularly the Magnificent 7, soar anew, largely driven by the burgeoning AI industry. This pivot to AI rekindled investor enthusiasm, cementing these companies as the must-own stocks and leaving the rest trailing.

The Spectacle of Passive Investment and the Echoes of History

Today, the investment landscape is increasingly characterized by momentum-chasing. Approximately two-thirds of global passive investments flow into U.S. stocks, with a significant portion directed towards the Magnificent 7, often irrespective of their valuations. This trend is echoed in the behavior of large active money managers and hedge funds, reminiscent of historical market patterns that have often led to dramatic corrections.

Historical Parallels: Lessons from the Past

The 1960s Conglomerate Bubble

The 1960s saw conglomerates like ITT and LTV expand aggressively, driven by favorable conditions and accounting practices. However, this bubble burst due to rising interest rates and regulatory shifts, leading to a steep decline in shareholder equity.

The Nifty-Fifty Bubble of the 1970s

The Nifty Fifty era was defined by the meteoric rise of fifty large-cap stocks. However, their inflated valuations couldn’t sustain the momentum, resulting in significant losses during the 1973-1974 market crash.

The 2000 TMT/Tech Bubble

The late 1990s were marked by rampant speculation in tech stocks, culminating in a dramatic burst in 2000. Companies like Qualcomm and Cisco Systems, once market darlings, experienced severe declines, offering a stark reminder of the risks of overvaluation.

The Future: Caution and Perspective

The current market dynamics, heavily influenced by the Magnificent 7, raise important questions about the sustainability of such concentration. Are we on the brink of a scenario akin to the late 1960s, 1973, or 1999-2000? Only time will tell. Investors should be wary of the potential for a low single-digit return decade for the S&P 500, a scenario reminiscent of past market corrections.

In conclusion, while the current market performance, led by the Magnificent 7, might seem enticing, it’s crucial for investors to heed the lessons of history. Diversification and a keen eye on valuation remain key tenets of prudent investing, especially in an era marked by such significant market concentration.

Value Investing’s Resilience: Sharks & Lightning Insights

Introduction: As steadfast believers in value investing, Hoover Capital Management (HCM) has always been intrigued by the interplay between base rates and case rates in both the market and nature.

Before delving deeper, let’s define these crucial terms:

Base Rate: In investing, as in assessing natural phenomena, the base rate refers to the underlying frequency of an event in a broad context. It’s the general occurrence rate that we can expect under normal conditions. In the context of value investing, this relates to the consistent, long-term performance trends observed over time.

Case Rate: Contrasting with the base rate, the case rate focuses on specific, often sensational instances. In financial markets, this can be compared to sudden surges or drops in stock prices or market segments, akin to rare but high-impact events in nature.

These concepts, much like the phenomena observed in the natural world, offer HCM practical insights for navigating the often-turbulent waters of investing. For example, while the annual chance of a shark attack is only about 1 in 11.5 million, it often garners disproportionate attention, similar to how sensational growth stock stories can overshadow solid value investing principles. The allure of growth investing (the case rate) can be compelling, especially during high-flying periods, but HCM views these times with the same cautious scrutiny one would reserve for rare, yet often overstated, natural events.

Section 1: The Steady Hand of the Base Rate – Value Investing Value investing represents the base rate in investing, akin to the frequency of shark attacks in nature. Despite their sensational portrayal in the media, the likelihood of an individual being bitten by a shark is incredibly low, estimated at 1 in 11.5 million. This low base rate of incidents reflects the true risk, much like how value investing operates on the principle of looking at the long game, focusing on stocks undervalued relative to their intrinsic worth. Historically, this approach in investing, as in understanding the real frequency of these natural occurrences, provides HCM with a stable foundation, rewarding with steady returns over decades – a testament to the resilience of value investing and the power of compounding.

Historical Insight: The Dot-Com Bubble
A pivotal example that highlights the stability of value investing is the Dot-Com Bubble of the late 1990s. This period saw a surge in investments in internet companies, driven more by growth expectations than by fundamentals. When the bubble burst in the early 2000s, it led to significant market corrections and the permanent loss of capital. Investors who adhered to value investing principles, focusing on fundamental valuations, were better insulated from these dramatic market fluctuations. This event underscores the importance of maintaining a disciplined approach to investing, as championed by HCM.

Section 2: The Siren Call of the Case Rate – Growth Investing Growth investing, on the other hand, epitomizes the case rate, much like the incidence of lightning strikes. The odds of being struck by lightning in a given year are about 1 in 500,000, yet the event is dramatic and powerful, capturing everyone’s attention. This is similar to the periods in growth investing, like from 2017 to 2020, where companies like Facebook, Apple, Netflix, Microsoft, Amazon, Google, and even Tesla saw their valuations soar, often detached from traditional valuation metrics. The tech-driven growth stocks soared to new heights, resembling capturing lightning in a bottle – exhilarating but often fleeting. However, just as one would approach a thunderstorm with caution, aware of the relatively low but impactful chance of a lightning strike, HCM views such explosive growth periods with a discerning eye, recognizing the volatility and risk inherent in such growth-focused strategies.

Section 3: Navigating Market Cycles with a Value Investing Compass Using the insights from these case rate periods to reinforce investment philosophy, while growth stocks may lead the charge during certain market phases, the fundamental principles of value investing remain HCM’s guiding star. HCM believes in the importance of not overpaying, regardless of market euphoria. It’s about finding quality stocks at reasonable prices and holding onto them through market cycles.

Empirical Evidence: The Long-Term Outperformance of Value Investing To solidify HCM’s discussion with empirical data, we present a pivotal chart that outlines the performance of the value factor over time, courtesy of the data compiled by Kenneth R. French from his renowned data library, specifically the Fama French Factor-HML, representing the value premium. The data spans from 1926 to September 30, 2023, offering a comprehensive view of nearly a century’s performance.

This chart vividly illustrates the long-term outperformance of value investing or the base rate from the starting point of 1926 right up to September 30, 2023. The value factor—measured as the difference in returns between high book-to-market stocks and low book-to-market stocks—shows a general upward trajectory, indicating that over this extended period, value investing has historically outperformed growth investing.

Conclusion: As we conclude, let this analysis serve as a reminder of the enduring strength and resilience of value investing. It echoes the sentiment that while the market may occasionally be swept up in the exuberance of growth stocks, it’s the steadfast commitment to finding undervalued assets that has historically paid off. For those with the foresight to look beyond the transient dazzle of growth, the enduring strength of value investing lies in wait.

Templeton’s Guide to Value Investing

In the world of investing, there are few names as revered as Sir John Templeton. A pioneer of global investing and the founder of the Templeton Growth Fund, Templeton’s investment philosophy has stood the test of time, consistently delivering value to investors. His approach to investing, which emphasizes value and contrarian thinking, resonates strongly with our philosophy here at Hoover Capital Management.

One of Templeton’s most famous quotes encapsulates his approach to investing:

“The ordinary investor will hear that X corporation has a good outlook, and he rushes in to buy the stock. Nine chances out of ten, that’s a mistake because if obviously it has a good outlook, the price already reflects that. And then if there should be any change in its outlook, the price will go down. So he’s basing his investment selection on something that is misleading him nine times out of ten. So you have to buy those things that other people are selling. Otherwise, you will never get a bargain. Don’t ask yourself, does this company have a good outlook? Ask yourself, how cheap is it? How unpopular is it? If you find that you’ve found a stock that investors say, oh that’s terrible, I wouldn’t buy that. That’s the one to buy.”

This quote underscores the essence of value investing – the pursuit of stocks that are undervalued by the market. This philosophy is at the heart of our approach at Hoover Capital Management. But how do we apply this philosophy in today’s complex and fast-paced market environment? Let’s break it down.

1. Look Beyond the Obvious

Just like Templeton, we at Hoover Capital Management caution against the herd mentality. Just because a company has a good outlook doesn’t mean it’s a good investment. The market has likely already priced in this positive outlook. The key is to look beyond the obvious, to find value where others may not see it.

2. Embrace Unpopularity

Templeton advises investors to buy what others are selling. This contrarian approach, which is a cornerstone of our investment strategy at Hoover Capital, can be challenging, as it often means going against prevailing market sentiment. However, it is in these unpopular stocks that one can often find the greatest bargains.

3. Focus on Value, Not Outlook

Rather than asking if a company has a good outlook, Templeton suggests asking how cheap and unpopular it is. This shift in perspective, which is integral to our approach at Hoover Capital, can help investors identify undervalued stocks that have the potential for significant price appreciation when the market corrects its undervaluation.

4. Don’t Shy Away from ‘Terrible’ Stocks

Finally, Templeton suggests that the stocks that investors are most averse to may be the ones worth buying. This doesn’t mean buying into companies with poor fundamentals or unsustainable business models. Instead, it means identifying companies that are temporarily out of favor but have strong underlying value. This is a principle we adhere to at Hoover Capital, as we seek to uncover value where others may not see it.

In conclusion, Templeton’s investment philosophy encourages a contrarian, value-focused approach. It’s about finding hidden gems in the rough, those stocks that are overlooked or shunned by the majority of investors but hold significant potential for value appreciation. At Hoover Capital Management, we resonate with this philosophy and strive to apply these timeless principles in our investment strategy. As we navigate the complexities of today’s global markets, the wisdom of Sir John Templeton serves as a guiding light, reminding us of the timeless principles of value investing.

Value Investing: Exploring the Reasons Behind Its Historical Outperformance

Value investing, a strategy that involves buying securities that appear underpriced by some form of fundamental analysis, has historically shown to outperform other investment strategies for several reasons:

Market inefficiencies: Despite efficient market theory, which states that all available information is already factored into a security’s price, markets can often misprice securities. This can be due to cognitive biases, overreaction to news, or simply neglect. Value investors seek to exploit these inefficiencies by purchasing stocks that they believe are underpriced.
Margin of safety: The margin of safety is a principle of value investing where investors only buy stocks when the market price is significantly below its intrinsic value. This not only increases the potential for profits but also minimizes the downside risk if the assessment of the intrinsic value was wrong.
Long-term approach: Value investing usually requires a long-term investment horizon. This is because it often takes time for the market to recognize a company’s true intrinsic value. In the long run, this can lead to significant gains.
Focus on fundamentals: Value investing involves detailed analysis of company fundamentals, such as earnings, dividends, book value, and cash flow. This thorough analysis can lead to a more accurate understanding of a company’s true value and less reliance on speculative factors.
Contrarian nature: Value investing often involves going against the grain of popular market trends. This contrarian strategy can be beneficial because it avoids buying into overhyped stocks that may be overvalued.
Dividend yield: Value stocks often pay consistent dividends, which can provide a steady income stream and contribute to total return.

While value investing has historically been successful, it’s also important to note that it requires a great deal of skill, research, and patience, and it may underperform in some market conditions. During certain periods, like during the tech boom of the late 1990s or in other growth-focused markets, value investing may not perform as well as other strategies.

The Art of Value Investing

The Art of Value Investing: Unlocking Hidden Gems in the Stock Market

Have you ever wondered how some investors seem to have a magic touch when it comes to picking winning stocks? They don’t rely on luck or gut feelings; instead, they follow a strategic approach called value investing. Value investing is a time-tested investment strategy that focuses on identifying undervalued stocks and holding them for the long term. In this blog post, we will explore the principles of value investing, its benefits, and how you can get started on your own journey to becoming a successful value investor.

Unveiling the Essence of Value Investing

Discovering Hidden Value

At its core, value investing is all about buying stocks that are priced lower than their intrinsic value. In other words, value investors seek out companies that have strong fundamentals but are currently undervalued by the market. They believe that over time, the market will recognize the true worth of these stocks and their prices will rise accordingly. This approach allows investors to capitalize on market inefficiencies and profit from the long-term growth potential of undervalued companies.

The Power of Patience

Patience is a key virtue for value investors. Unlike short-term traders who are constantly chasing quick profits, value investors take a long-term view of their investments. They understand that it takes time for the market to recognize the hidden value in a stock, and they are willing to wait patiently for this to happen. By avoiding the temptation of frequent trading, value investors can benefit from compounding returns and minimize transaction costs.

Embracing Margin of Safety

One of the fundamental principles of value investing is the concept of a margin of safety. This refers to the difference between the intrinsic value of a stock and its market price. Value investors always seek stocks that have a significant margin of safety, as this provides a cushion against any unforeseen market fluctuations or company-specific risks. By buying stocks at a discount to their intrinsic value, value investors minimize their downside risk and increase their potential for higher returns.

Getting Started with Value Investing

Do Your Homework

Successful value investing requires thorough research and analysis. Start by identifying companies with strong fundamentals, such as a robust balance sheet, consistent earnings growth, and a competitive advantage in their industry. Look for stocks that have been overlooked or undervalued by the market due to temporary setbacks or negative sentiment. Dig deep into financial statements, industry trends, and company news to gain a comprehensive understanding of the potential investment. You can learn more about how an investment process is set up to do this, refer to our website, hcmvalue.com/investment-process/

Develop a Disciplined Approach

Value investing is not about making impulsive decisions based on short-term market movements. It is a disciplined approach that requires sticking to a well-defined investment strategy. Create a set of criteria for identifying undervalued stocks, and stick to it religiously. This will help you avoid emotional decision-making and stay focused on the long-term value of your investments.

Learn from the Masters

Value investing has a rich history, with legendary investors like Warren Buffett, Benjamin Graham, David Dreman, and John Neff, paving the way for future generations. Study their investment philosophies and learn from their successes and failures. Reading books, attending seminars, and following value investing blogs can provide valuable insights and guidance for your own investment journey. For example, you can read ‘The Intelligent Investor‘ by Benjamin Graham, which is considered a classic in the field of value investing. Another insightful read is ‘Contrarian Investment Strategies: The Psychological Edge‘ by David Dreman. These books provide a wealth of knowledge for anyone looking to delve deeper into the world of value investing.

The Rewards of Value Investing

Long-Term Wealth Creation

Value investing has proven to be a highly effective strategy for long-term wealth creation. By buying undervalued stocks and holding them for the long term, investors can benefit from the compounding returns and the growth potential of these companies. Over time, the market tends to recognize the true value of these stocks, leading to significant capital appreciation and wealth accumulation.

Risk Mitigation

Value investing inherently incorporates a margin of safety, which helps mitigate risks associated with investing in the stock market. By buying stocks at a discount to their intrinsic value, value investors reduce the downside risk and increase the probability of favorable investment outcomes. This approach provides a level of protection against market volatility and unexpected events.

Focus on Fundamentals

Value investing forces investors to focus on the fundamentals of a company rather than short-term market fluctuations. This approach allows investors to make informed decisions based on the underlying strength and potential of a business, rather than being swayed by market hype or sentiment. By focusing on fundamentals, value investors can avoid the pitfalls of market speculation and make rational investment choices.

Conclusion

Value investing is a time-tested investment strategy that offers the potential for long-term wealth creation and risk mitigation. By identifying undervalued stocks, practicing patience, and maintaining a disciplined approach, investors can uncover hidden gems in the stock market. While value investing requires thorough research and analysis, the rewards can be substantial. So, if you are ready to take a thoughtful and strategic approach to investing, value investing may be the key to unlocking your financial goals.

Neuroscience and Investing?

Neuroscience and Investing: Enhancing Global Value Strategy through Emotional Intelligence

HCM believes it’s crucial to recognize the profound influence of ‘affect’ or emotional responses on investment decisions. Drawing lessons from the dot-com bubble, the FANMAG (Facebook, Amazon, Netflix, Microsoft, Apple, Google) era, and the most recent surge in AI-centric businesses, such as Nvidia, can provide valuable insights.

Learning from the Dot-Com Bubble

The dot-com bubble that bloomed and burst between the late 90s and early 2000s serves as a powerful case study of the extent to which intense emotions and investor sentiment can inflate stock prices to unsustainable heights. Triggered by a fervent optimism about the transformative potential of the internet, this era saw a remarkable overvaluation of tech stocks. Investors, caught up in the allure of the burgeoning Internet economy, began ignoring traditional valuation metrics and probabilities.

This period offers critical takeaways for a global value investor. Amid such market frenzy, it is imperative to adhere to the principles of value investing, focusing on companies undervalued by the market, and maintaining a disciplined approach to buying stocks at prices below their intrinsic value.

The FANMAG Era: 2018-2020

The rise and dominance of FANMAG stocks between 2018 and 2020 showcases a more recent example of affect-driven investment trends. These tech behemoths, due to their robust market positions and impressive growth rates, became the apple of investors’ eyes. However, their popularity also heightened their potential for overvaluation, as investors flocked to these popular stocks, driven by FOMO (fear of missing out), often neglecting other promising opportunities.

During such times, a value strategy can be improved by maintaining a diversified portfolio and avoiding over-concentration in a single sector or small group of stocks, irrespective of how enticing they seem. Additionally, investors should keep in mind the mounting regulatory scrutiny these tech giants face, which adds another layer of uncertainty.

The AI Surge: The Nvidia Paradigm

The current surge in AI and related tech companies, with Nvidia at the forefront, highlights another context where ‘affect’ significantly influences investment decisions. The accelerated advancements in AI and machine learning have rendered companies like Nvidia extremely attractive to investors. Currently, Nvidia trades at an astounding 40 times its revenue, a lofty valuation by any measure. The risk here lies in investors being overly optimistic about the company’s growth prospects, potentially ignoring the inherent risks tied to such high valuations.

Value investors should exercise caution amid such hype. Although AI signifies a major growth area, not every company in the sector will necessarily live up to the high expectations set by their current valuations. As such, it’s vital to conduct an exhaustive fundamental analysis and not let the excitement surrounding the sector cloud sound judgment.

The Neuroscience Connection

The connection between neuroscience and investing becomes increasingly relevant as we seek to understand the cognitive and emotional processes underlying investment decisions. Recent research has been delving into the neural basis of decision-making, particularly in uncertain and risky situations, like investing. Brain-imaging studies have demonstrated that specific regions of our brains become active when we experience different emotions. The amygdala, for instance, becomes active during fear and anxiety, emotions often felt by investors during a market crash.

The burgeoning field of ‘neurofinance,’ which applies neuroscience to understand financial decisions, can provide illuminating insights. By understanding the neural mechanics behind affect and emotion-based decision-making, we can construct a more robust mental framework to counter these influences in our investment journey.

To sum up, enhancing the efficacy of a global value investment strategy in the face of affect-driven trends requires a blend of historical understanding, disciplined analysis, and a diversified approach. This strategy involves not being swayed by market sentiment, maintaining a diligent focus on fundamentals, and keeping a composed perspective amidst the emotional tides of the market. The interplay of neuroscience and investing can be harnessed to create a more informed and emotionally intelligent investor.