The glory days of value investing look like they are well and truly behind it. After taking a beating from the phenomenal rise of growth stocks and the passive investing revolution, it now has to face people moving markets by sheer force of personality and internet forums. But what is value investing? What are the threats to this school of investment thinking and what do I think the prospects for it are? I will address all these in this post.

Value investing is based on the idea that the market is not efficient in pricing assets. Sometimes assets are worth much more than the market think they are and there are gains to be made if you purchase them at the current price and wait for the market to eventually realize the true asset values. The value investing philosophy is characterized by a love for mature companies in traditional industries, comprehensive analysis of financial statements, the use of traditional valuation models like Price-to-Earnings Ratio, Dividend Discount Model, Discounted Cash Flow Analysis, EV/EBITDA and so on, a general skepticism towards new business models that only few understand, and the belief that a business’ fundamentals are more important in the long run than the general market sentiments.

An illustration of how a value investor thinks can be made using the case of MTN. In 2018, MTN Ghana offered shares to the public at GH¢0.75/share. A rally saw it climb to around GH¢0.96/share before it fell again below its IPO price. An analyst could look at MTN Ghana’s position in the industry and their financial performance and decide that the company is worth much more than it is currently trading for. (This is just an illustration of the thought process not my personal thoughts on the stock.)

For many years, value investing was the dominant philosophy among professional investors. Pioneers like Benjamin Graham, Warren Buffett and Charlie Munger were practically worshipped. However, value investing has been getting a strong challenge from an alternative philosophy known as growth investing.

Like its name suggests, growth investing refers to investing in emerging companies or new industries at early stages in order to reap phenomenal returns. Because growth investing looks at companies in their early stages, traditional valuation methods may not be able to value the companies because they usually have little to no earnings to speak of and are likely to be running at a loss. The dot-com bubble of the early 2000s was a big blow to growth investing because a lot of large bets by growth investors in internet companies turned out to be bad investments and value investors like Warren Buffett came out of the bubble looking more brilliant than ever.

However, the mind-blowing stock performance of companies like Facebook, Amazon, Alphabet (Google), Apple and Netflix has made growth investing look like the way to go for many investors. Include the Venture Capital (VC) scene which has catapulted start ups like Tesla, Uber, Lyft, AirBnB and Snap into global giants and you realize that many young investors have shifted their adulation from Buffett to people like Elon Musk and Marc Andreessen. Instead of reading The Intelligent Investor people are watching Shark Tank.

Standing against both these investing philosophies is the passive investing philosophy championed by the late great Jack Bogle. Bogle founded Vanguard Group in 1975 after his experience in the investment business had convinced him that it was better to try to allocate your portfolio in a way to track the average market return rather than try to pick winners and losers from the stock market. (For more on Bogle and passive investing please read this.)

Let me not even get started on meme investing, the name coined to describe retail traders gathering on internet forums (most prominently Reddit’s r/wallstreetbets) to pump stocks to the moon. The finance world was shocked when the price of GameStop rose from less than $20 to a high of $483 not on a value or growth play but because of the activities of the most influential people on that internet forum with big help coming from billionaires Elon Musk and Chamath Palihapitiya.

So in an investing environment in some individuals look like they can move markets at will, an environment in which businesses can be worth billions without generating $1 in profit, and an environment in which millions of retail traders pick stocks from an app, is there any hope for value investing? Yes, there is. Value investing will always be relevant.

This is not based on any nostalgia for days past. In fact, my sympathies lie mostly with the passive investing team. Nevertheless, value investing is due to make a return in a big way. I see three reasons why this is likely to happen.

Growth stocks turning into value stocks. No company can remain a growth company forever. Smartphone manufacturers can do all the iterations they want but they cannot convince people that they are creating new products. Eventually the companies that will survive these uncertain times will look more like producers of staples with little growth but a solid balance sheet. And that is what value investors are best at evaluating.

The popularity of retail trading is cyclical. You might think that easy access to trading assets is the biggest determinant to people owning stocks. I mean, it looks like everyone these days has access to a broker who allows them to trade regularly (and sometimes with no fees) but take a look at the chart below. It shows US households’ and non-profit organizations’ stock ownership as percentage of disposable income.

As you can see, people put relatively more money in stocks in the 1950s than in the 1980s. People put as much money in stocks in 1999 as they did in 2019. This is not simply a matter of the ease of owning stocks at play. Instead of seeing the rise in retail trading as a new permanent fixture that fundamentally changes investing (since retail investors are wont to buy and sell the same stocks in droves) it seems more accurate to view the phenomenon as something that is going through a temporary boom.

A crash. A market crash is inevitable. But whether it will happen in 5 months or 5 years, nobody knows. But when it does happen, there will be a spectacular exit from the market and the need to value companies based on the old boring metrics of their earnings, free cash flows and total assets will be back in vogue.

Value investing, like growth investing, will never go away. In a way they complement each other. Growth investors take large risks to finance new industries, and value investors prevent negative market sentiments from affecting companies with strong fundamentals. We can be certain that both will be around for a long time to come. I’m not sure what the future holds for meme investing though.