The WSJ article, "Investors Finding Little Value in Value Stocks, So Watch for the Rebound," states the following:
The U.S. stock market is showing the biggest divergence between cheap and pricey stocks since the aftermath of the dot-com bubble, as investors chase the performance of companies with rising earnings.
Valuation of growth companies-those able to show rising earnings, typically priced at a premium-have soared this year even as price/earnings ratios of cheap, so-called "value" stocks slid, an unusual separation.
Growth and value stocks in the U.S. returned the same from the start of the post-Lehman recovery in 2009 until January this year, thanks to a surge in cheap stocks after the U.S. election a year ago. Since then, the 19 percentage-point outperformance of growth stocks is the most in such a short period aside from the last year of the dot-com bubble....
A New Era?
This year's divergence suggests investors are starting to bet on a new era, that new technologies will disrupt business plans. A firm belief in a modern age of technology has been behind many historical bubbles, from the canal mania of 18th-century Britain to the brief over excitement about 3-D printing in 2014. I do believe in the new era where new technologies will transform industries, but I do not think the growth in earnings projected for the growth companies is sustainable, and that over-hyped stocks will get too expensive while cheap stocks will get too cheap due to investor sentiment. It will get to a point where you have a value gap that is so extreme that quite often that can act as a catalyst for the value stocks (cheap stocks) to rebound by itself. The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.
Why Projected Earnings For Certain Companies Are Unsustainable
Here is why I think the projected earnings for certain growth companies are unsustainable:
The faster these companies grew, the more expensive their stocks became. And when stocks grow faster than companies, investors always end up sorry. Growth stocks are worth buying when their prices are reasonable, but when their price/earnings ratios go much above 25 or 30, the odds get ugly.
- Journalist Carol Loomis found that from 1960 through 1999, only eight of the largest 150 companies on the Fortune 500 list managed to raise their earnings by an annual average of at least 15% for two decades.
- Looking at 5 decades of data, the research firm of Sanford C. Bernstein & Co. showed that only 10% of large U.S. companies had increased their earnings by 20% for at least 5 consecutive years; only 3% had grown by 20% for at least 10 years straight; and not a single one had done it for 15 years in a row.
- An academic study of thousands of U.S. stock from 1951 through 1998 found that over all 10-year periods, net earnings grew by an average of 9.7% annually. But for the biggest 20% of companies, earnings grew by an annual average of just 9.3%.
Why I Think Putting All Eggs In One Basket Isn't The Way To Go
The intelligent investor, however, gets interested in big growth stocks not when they are at their most popular-but when something goes wrong.
Also, obvious prospects for physical growth in a business do not translate into obvious profits for investors. While it seems easy to foresee which industry will grow the fastest, that foresight has no real value if most other investors are already expecting the same thing. By the time everyone decides that a given industry is "obviously" the best one to invest in, the prices of its stocks have been bid up so high that its future returns have nowhere to go but down.
The majority of companies have come to follow what may be called a standard dividend policy. This has meant the distribution of two-thirds of their average earnings, except that in the recent period of high profits and inflationary demands for more capital the figure has tended to be lower. However, an increasing number of growth companies are departing from the once-standard policy of paying out 60% or more of earnings in dividends.
On The Other Hand
Having said that, Charlie Munger would rather pay a fair price for a quality company than a cheap price for a stinker.
Is value investing dead? Do you think the earnings projections for certain growth stocks are on the wild side? What growth stocks are you bullish on, monkeys?