On the Market with Jack & Lowell

Burney Company Chairman and Founder Jack Burney and President Lowell Pratt Jr., CFA both have extensive experience investing in equities, the former founding the company over 40 years ago and the latter with 30 years of experience. From time-to-time, we share their conversations on the stock market and investing. Below are excerpts from a recent conversation regarding Value vs. Growth stocks:

Jack Burney: AAII Journal published an interesting article entitled “Why Value Beats Growth: A Brief Explanation.” 

“Value stocks have outperformed growth stocks by a cumulative 3,200% since 1926!”.    The main reason, the author asserts is that “value stocks reflect compensation for risk.” 

Can that be true??

Lowell Pratt Jr., CFA: It depends on one’s definition of risk, but this is the official academic defense of Value’s excess return in an “efficient” market.  The case is easier to make for Small-Cap stocks’ excess return as Small-Cap stock prices are inherently more volatile and thus riskier in the classic sense of the term.  Value stock prices are not inherently more volatile, so a different sort of risk has to be conjured.  For instance, risk can be defined by things like poorer growth prospects, lower profitability, worse management or whatever other reasons academics can hypothesize to support theory.  

However, as we know from firsthand experience from our time as committed Value investors, there is a reasonably legitimate case to be made for Value stocks being riskier: They are harder to own when the market cycles away from them.  When the market favors Growth, it is much easier for investors to stick with their wonderful albeit lagging Growth stocks. After all, these are companies have tremendous growth prospects, excellent profitability and stellar management.  Surely in time patience will be rewarded for owning such companies.  On the other hand, when the market cycles away from Value, justifying patience with a portfolio full of Value “dogs” is much harder.  And if an investor doesn’t stick it out through cycle lags, they will not capture Value’s excess return.  A tad convoluted, but in this sense Value stocks are indeed riskier.