What's in a name? Value versus growth

April 19, 2023

“Often, when faced with an unknown phenomenon, we react by approximation: we seek that scrap of content, already present in our encyclopaedia, which for better or worse seems to account for the new fact.”

      - Umberto Eco

The notion of uncovering an ancient Chinese encyclopaedia named ‘The Celestial Emporium of Benevolent Knowledge’ might conjure images of daring escapades and Indiana Jones. Referenced by the Argentine writer, Jorge Borges, in a 1942 essay that, in part, discussed the attempts of mankind to categorise the world around them, it purported to demonstrate that there are fourteen categories of animals, including: i) those that belonged to the Emperor, ii) embalmed ones, iii) fabulous ones, iv) stray dogs and v) those that, at a distance, resemble flies.

As with most things that seem too good to be true, the encyclopaedia is fictitious (Borges irreverently attributed it to the prolific German translator of Chinese works, Franz Kuhn.) However, the point being demonstrated, namely that classification is often arbitrary and, in many ways, speculative, is a perpetual one. It is also an act that human beings seem permanently reliant on to comprehend, or rationalise, the world around them.

Modern financial markets, especially since the introduction of computerisation, have become behemoths straddling the globe and operating at ever increasing speeds. When faced with this complexity, categorisation may feel almost like a necessity in order to grasp their inner workings. However, there are numerous issues with this seemingly latent need for classification. The first of these resides in the reductionist nature of categorisation; it is the fastest way for nuance and detail to become lost in a mire of labelling and generalisation.

Take the labels growth and value, so often used to separate stocks within equity markets. These have become so engrained in the investing vernacular that swathes of the market are now geared to service them, such as the thousands of indices and mutual funds claiming to grant access to the facets associated with each label. Interest in the latter category of stocks has seemingly emerged from a long slumber as the outperformance of growth companies (often lazy shorthand for US technology businesses) has eased, having held sway for most of the last decade.

However, only a light scratch at the surface reveals the extraordinary breadth and depth of different companies so often lumped into these two categories, frequently only loosely linked by some vague common metric or ratio. This issue is compounded by the fact that, in reality, growth and value are intrinsically connected; it would appear a false dilemma to force this segregation, and to portray them as mutually exclusive. Perhaps this points to a deeper issue with reactionary labelling: it isn’t necessarily the labels themselves which are the issue, but the meaning we attach to those labels.

There are two interesting elements within this debate that appear worthy of further examination. The first is the grey area where companies display attributes of both value and growth either on a permanent basis, or in moments of economic disruption. Using an Axioma model to find companies that display both Value and Growth characteristics (in our example, Value = Price-to-Book and Growth = equal-weighted sales growth and earnings growth, both historical and forward looking) some interesting case studies emerge.

Take the marine shipping company, AP Moller Maersk. Our model has assigned Maersk a Value value of 1.46 and a Growth value of 1.21 (meaning the company is more than one standard deviation greater than the mean of both metrics and that the company sits comfortably within both categories.) However, what this simplistic application of analysis fails to demonstrate is why the company is indicating these credentials. The reasons are manifold, but broadly result from freight prices shooting up during the pandemic due to China-related lockdowns, a lack of air travel (since a large amount of international shipping is conducted in the hold of long-haul flights which temporarily dried up) and a distinct lack of symmetry in purchasing, causing an absence of shipping containers. Maersk and its peers benefitted from this and saw revenues double from circa USD40 billion in 2020 to over USD80 billion in 20221.

Even with a normalisation to consensus revenues of circa USD55 billion in 20232, this still gives a 10% revenue compound annual growth rate over these two years. These are strong growth attributes. This is reinforced by a significant cash position built up from retained earnings, which will be reinvested into a greener fleet, and a consolidation of Maersk’s market position. However, this cash position has effectively increased its equity position and the stock can now be found with a Price-to-Book value near its lowest in the last 10 years (0.64 times)3 given the share price did not track the improved growth profile of the business. These are strong value credentials.

This leads us to query why the company’s share price has not performed in line with how the headline metrics would suggest they should, ultimately leading to a relatively banal conclusion: in the longer term, very little can or should override company fundamentals. Bottom-up analysis, while hardly a panacea to the complexities of equity investing, offers a unique opportunity for investors to locate the detail so integral to comprehending likely stock behaviour in the longer term.

The second interesting element of the categorisation debate is the faculty of labelling to affect the behaviour of its underlying constituents, sometimes consciously, but often the reverse. While the underperformance of value stocks over the last decade was driven to a large extent by the prevailing macroeconomic climate of zero interest-rate policy - thereby creating an environment of extremely cheap money and the pressure for investors to move further out on the risk curve - there may also have been a behavioural element. Where a company is classically labelled as a ‘value stock’, the restriction of capital based solely upon that label during a period of economic ‘style certainty’ becomes a self-reinforcing feedback loop, often agnostic to underlying business fundamentals. This is a phenomenon that has been obvious in certain areas of the ESG and technology investing arena, whereby capital is funnelled to companies based not on the business itself, but its inclusion within the umbrella of tech or ESG indices, funds, and industries. Put another way, the tail may have been wagging the dog.

A final and perhaps more dangerous pitfall of categorisation is linked to the colossal rise of these new investing paradigms, when existing categories and structures are used to understand the new and innovative. To understand this phenomenon, you could do worse than to revert to the theme of Borges’ faux taxonomy. When the crew of Captain Cook’s HMS Endeavour first struck upon Australia in 1770 they were faced with an animal so unlike anything they had seen before that they were forced into entirely inappropriate avenues of comparison in an attempt to explain it. Cook himself wrote that this beast was “of a light Mouse colour and the full size of a grey hound and shaped in every respect like one, with a long tail which it carried like a grey hound.” Although not immediately apparent, he was describing a kangaroo. Whilst understandable, this utilisation of existing frameworks to understand the unprecedented can ultimately lead to false facets being attributed.

As investors, this leads us to believe there is little substitute for ever deeper research and detailed understanding. We must query and question, be sceptical of approximation and labelling, and try to see the world for what it is, not what we want it to be.

1 www.maersk.com.
2 Bloomberg 2023.
3 Bloomberg 2023.

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