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Relocating Value



An Unwarranted Demise. Value investors in the U.S. extol the virtues of patience and resolve as their under-performance reaches two decades. For those attentive to the changing world around them, the tail told for the demise of value investing is incoherent with the global reality. Value investing is thriving in the regions where one would expect it: those with high fixed investments. China and other countries that are the goods export engine of the world delivered impressive returns for value investors over the last decade. This outcome is logical because countries that focus on services (e.g., the U.S.) are increasingly less fixed capital intensive and thus deliver a decreasing value factor exposure. The international value factor is alive and well. As the global economy evolves, so should investors.


Profit Momentum. The last decade was troublesome for traditional security analysts. The hallmark of fundamental analysis was thrown asunder as value under-performed as a factor in the developed markets (Exhibit 1). The hope for reversion to the mean never occurred, and the value factor has now delivered two decades of under-performance. This depressing performance tests the resolve of stalwart value investors. In contrast, investors in the technology monopolies are resplendent in their promised early retirement. Yet, the dichotomy between the two is not evident upon closer inspection.


Profit as a motivating factor for investment is clear. Higher profit growth delivers higher value to the investor. This outcome is dear to all fundamental investors who seek stable and growing earnings. The durability of the global technology companies’ moats has not been this secure since the heyday of rail in the nineteenth century. The difference this time is that the monopolies are global rather than national. Thus, the profit factor has outperformed for over two decades. Indeed, for those less inclined to security analysis, following momentum was equally remunerated. It seems that companies with high tangible book values are unrewarded. Yet, this is not entirely truthful.


Exhibit 1. Fama & French Equity Developed Markets Factor Returns

Source: Kenneth R. French website. Data as of June 2021. CRM Calculations.


Location Matters. While the developed markets enjoyed some reward for their factor exposures, the same is not valid for the dutiful U.S. factor investor. Most factors were not rewards over the last decade, with the profit and momentum factor eking out minor gains (Exhibit 2). The challenge is that it followed a prior decade of trivial returns. Once accounting for the last year’s increases, the only significant positive returns belong to the profit factor.


The value factor is the most disappointing one in the U.S. as its negative performance exceeds two decades. Long-term investors will extol reversion to the mean and patience. Yet, as the time horizon extends into decades, their resolve is supremely tested. The challenge may reside in the generational shift occurring for who is investing.


The value renaissance started in the 1970s and endured until the 1990s technology bubble. This outcome is significant because these investors never knew anything but value as the dominant paradigm. As the secular trend shifted in the Aughts, they persisted with what made them successful. As globalization and technology’s monopolistic practices enabled profits not seen in a century, the value factor followed the trade patterns and shifted locations.

Exhibit 2. Fama & French U.S. Equity Market Factor Returns

Source: Kenneth R. French website. Data as of June 2021. CRM Calculations.


Relocating Value. The entry of China into the World Trade Organization (WTO) in 2001 changed trade and investment dynamics. The high investment rates in China built out infrastructure at a speed that had no contemporary parallels. Eager to remove the burden of fixed costs, U.S. firms outsourced a material component of the manufacturing. The key measure of the value factor, book (i.e., fixed assets), moved as well (Exhibit 3). Investors extol the loss of value in the U.S. yet ignore its success in Asia and the Emerging Markets (and in Europe and Japan) is a startling disconnect.


The U.S. factor market performance leaders are bifurcated into the mega-capitalization technology stocks and the less liquid small-capitalization stocks. The small-cap stock performance is primarily a function of the startling rise in the prices over the last year. This insight leaves profit as the reigning factor in the U.S. (and everywhere). Elsewhere it is the value factor and momentum. The former is not surprising given the change in trade patterns. As for the latter, when small markets face substantial cash inflows, momentum should dominate. While Europe in aggregate is large, each country within it is not, contributing to the momentum factor. Value is alive and liquidity matters.


Exhibit 3. Fama & French Equity Regional Markets Factor 20-Year Returns

Source: Kenneth R. French website. Data as of June 2021. CRM Calculations.


Fungible Products. The success of the U.S. technology companies over the last two decades generated enormous wealth. Investors now clamor to find the next unicorn in hopes of delivering the next 100X investment. This decision has lifted the private equity (PE) and venture capital VC market values to multi-trillion-dollar levels. The end game for them is a public listing. Initial Public Offerings (IPO) median first-day market values are at an all-time high (Exhibit 4). These flows impact the small-cap market materially.


The small-cap median market value is about $1.5 billion.[1] Thus, IPOs enter as prime candidates for the small-cap market index. The PE and VC markets are inaccessible to most investors, particularly small public market investors. They must wait for the IPO before accessing these investments. The first problem is that this market is only a twenty-fifth of the size of their larger brethren. This size difference ensures that flows from big to small will deliver an enormous impact, much like the one seen over the last year with the index more than doubling in value.


Exhibit 4. Initial Public Offerings Median Closing Market Value (Constant Dollars)

Source: Ritter, Jay R. 2020. Initial Public Offerings: Updated Statistics. Table 4f. Available at: https://site.warrington.ufl.edu/ritter/ipo-data/


Ethereal Value. Expected future profits are a critical determinant of present value. This trite statement is the crucial measure of financial analysis. Of course, predicting the market leaders’ decades hence is a Herculean task. The investors of Blackberry know that robust profits and a dominant market share don’t preclude a quick fall from grace as a new product enters markets (i.e., Apple’s iPhone). Yet, critical to these future winners is current profits, no matter how meager. Profits are where the current problem arises.


Earnings for IPOs are as rare as the unicorns that investors chase (Exhibit 5). In an investment environment where four out of five new listings have negative earnings, the search for value is elusive. IPOs have performed admirably over the last three years on their listing day, with positive gains for the median company. This outcome is despite the empirical evidence that companies without earnings foreshadow poor future returns. Only the Tech Bubble of 2000 exceeds these ethereal numbers. An investor looking for value should look elsewhere. In contrast, all investors should focus on changes of liquidity, particularly as the third-quarter earnings season approaches. Momentum is two-sided.


Exhibit 5. U.S. Initial Public Offerings Percent with Negative Earnings & Initial Returns

Source: Ritter, Jay R. 2020. Initial Public Offerings: Updated Statistics. Available at: https://site.warrington.ufl.edu/ritter/ipo-data/

[1] S&P Indices, August 2021. Median constituent market value.