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Not All PEs Are Created Equal
Value investing is out of favor. That may be a gross understatement. Growth has outperformed value in 8 of the past 10 years—2011 was a dead heat, and value bested growth in 2016 only to trail by a relative 14% over the next 2 years. According to some measures, growth stocks trade at a nearly 50% premium to their value counterparts. That should be cause for some optimism from the value crowd as such extreme disparities tend to sow the seeds of their own undoing. That said, we saw growth premiums stretch as high as 100% during the dot-com era.
We must admit we don’t spend much time worrying about this. We focus on the economics, not the machinations of the market per se or which way the winds of popularity blow. Economics endure and ultimately prevail.
So in this market of massive growth premiums, what is for sale in the value bin? Two industries stand out as “cheap” in today’s market: automotive and semiconductor, both full of companies trading at 10-ish times earnings or less, and both operating in cyclical industries. Cyclicality explains why both industries appear cheap, as the market often fixates on what is right around the corner rather than what is farther up the road. But the similarities largely end there. Some of the stronger companies in the semiconductor industry hold meaningful portions of their market caps in net cash. Most auto original equipment manufacturers (OEMs), in contrast, have balance sheets that are difficult to really disentangle and enterprise values that involve a lot of judgments. Many have effectively become banks (via their financing subsidiaries) with manufacturing businesses attached. And many have no net debt at their manufacturing businesses but massive debts at the financing subsidiaries.
The question of which one you would rather own quickly becomes a rhetorical one. As always, we are open to persuasion. But the comparison serves a further purpose—one that brings us back to our earlier observation about growth and value. Sometimes the comparison of growth versus value is a false one.
Around here, we often say that growth is a characteristic and value is a judgment. It’s our job to apply that judgment to an investment case with all its characteristics and determine whether there is good value. And we always prefer to invest in companies that have growth. Granted, companies experiencing what seems like perpetual, uninterrupted growth often get very high multiples that push them out of reach for value-oriented investors such as ourselves. There seems to be a lot of that going on these days. But not all growth is uninterrupted; it can be cyclical as well with each downturn and upturn ultimately higher than the last. Not all PEs are created equal, indeed.
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