Why value investing is facing a “tectonic shift”, according to veteran fund managers
The father of value investing, Benjamin Graham, still dominates Tweedy, Browne, the New York-based firm that served as his brokerage in the early 20th century.
The $5.9 billion
Tweedy, Browne International Value
(ticker: TBGVX) follows one of the famous investor’s key investment principles: buying stocks that trade at prices below their intrinsic values will create wealth over time.
Although Graham’s Principle of Intrinsic Value hasn’t changed in nearly 100 years since its inception, what’s different now are the metrics used to determine that value, says co-portfolio manager Thomas Shrager. Conventional measures such as book value, he notes, are less useful as markets have become more efficient.
One of the measures Shrager, 64, and his co-director Robert Wyckoff, 69, now use in their analysis is company value to earnings before interest and taxes, or Ebit. They look for valuation multiples between 10 and 15, but buy when these multiples are at significant discounts, ideally around 30%. These types of discounts are similar to what someone looking to buy the company would want to see, Wyckoff says.
“It just makes sense to try to buy companies at discounted prices relative to observable real-world valuations that have been paid for comparable companies,” he says.
The co-managers’ conservative strategy has paid off, especially for long-term investors. Over the past 15 years, international value has ranked in the top 1% of Morningstar’s foreign large value category, with an annualized return of 3.7%. Its benchmark, the MSCI EAFE, recorded an annualized return of 1.6% over the same period. In 2011, Morningstar awarded the International Value team of seven managers its International Stock Manager of the Year award.
Morningstar rates the No-Fee International Value as a five-star bronze fund, though the 1.37% fee for retail stocks is considered high by the research firm.
According to Wyckoff and Shrager, value investing is set to see even better days. The duo predict that the trend shift towards value that began in the fourth quarter of 2020 is a “tectonic shift”. As the global economy began to recover from the Covid-19 lockdowns, value stocks began to outperform growth stocks, as they typically do during economic rebounds.
The veteran team expects value dominance to accelerate now that the Federal Reserve is poised to raise interest rates several times to temper inflation. Higher interest rates weigh more heavily on growth stocks because more of their value is tied to earnings in the distant future. Plus, value stocks are simply cheaper than growth stocks after years of underperformance, Wyckoff says.
The pair’s years of experience and strong fund track record make their predictions worth considering. Wyckoff and Shrager have led the fund since 2007 and 2003, respectively, and have worked at Tweedy since 1991 and 1989.
The managers seek to build a portfolio with three types of companies, although all should have strong balance sheets, a diverse customer base and little debt.
The first are the pillars of the portfolio – high quality companies with strong brands and little competition that can increase in value over time. This is evident in the fund’s two main holdings,
(DGE.UK), each purchased over 20 years ago. These are the types of stocks that underline International Value’s 11% portfolio turnover.
The second type of holdings sought by the fund are cyclical companies with average levels of growth; they can keep these shares for three to five years. One example is Swedish manufacturer Trelleborg (TREL-B.Sweden), a stock that Wyckoff says remains at an attractive value. Rubber seals, one of its predominant products, are an inexpensive but essential component of machinery. “A company like this gets pricing power because they are critical to the ultimate success of the business,” he says.
Finally, Wyckoff and Shrager are attracted to companies with high added value, especially those whose insiders buy the shares. In February, the fund bought the Finnish company
(KEMIRA.Finland), a supplier of chemicals to water-intensive companies, for about 12 euros ($12.63) per share, close to the price paid by insiders. This represented a steep discount to its estimated intrinsic value of €17 per share.
Insider buying has also alerted executives to
(1882.Hong Kong), Taiwan’s largest manufacturer of plastic injection molding machines. Supply chain bottlenecks weighed on the stock price, and in January they bought around HK$21 ($2.68) per share, close to where insiders bought, a price between five to six times their normalized Ebit estimates. Wyckoff says the valuation multiple should be at least 10-11 times, implying a stock value of HK$28-30.
|1 year||5 years||10 years|
|Great foreign value||-11.6||2.4||4.7|
|top 10 holdings|
|Company / Symbol||% actives|
|Nestlé / NESN.Switzerland||5.3%|
|Diageo / DGE.FR||4.6|
|CNH Industrial / CNHI||3.7|
|Roche Holding / ROG.Switzerland||3.7|
|Berkshire Hathaway / BRK.A||3.5|
|Alphabet / GOOGL||3.3|
|TotalEnergies / TTE.France||3.1|
|United Overseas Bank / UOB.Singapore||3.1|
|GlaxoSmithKline / GSK.UK||2.9|
|SCOR / SCR.France||2.9|
Note: Holdings as of March 31. Returns through May 9; five- and ten-year returns are annualized.
Sources: Morningstar; Tweedy Browne
The fund has a 42% exposure to Europe but has little direct exposure to Russia and Ukraine. The war will have an indirect impact on holdings such as the Swedish automotive supplier
(ALV), says Shrager, since Ukraine was a major manufacturer of car harnesses. Rising raw material costs across the board could eventually flatten the operating profit of European industrial companies in the near term, he says. In general, Tweedy analysts always calculate the earnings power impact of rising input costs for all businesses.
The overall impact of inflation may be less of a concern for a value fund because it holds mature companies with cash flow, but it’s still a concern. Shrager says they are looking at their holdings to see which companies have the power to set prices to pass on higher costs, which should make up a large portion of their holdings.
Stock markets are expected to face tough times as they adjust to the Federal Reserve’s rate hikes, Wyckoff said. Still, he notes that when markets falter, the fund’s conservative strategy gains the most traction against its benchmark, thanks to its holdings’ strong balance sheets.
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