Charles Brandes - Why Value Investing Outperforms (Part 1)
Charles Brandes, founder of Brandes Investment Partners (1974), which today manages over $50-billion in assets, globally, discusses why value stocks outperform growth stocks and bonds over the long term, with Dan Richards, Clientinsights.ca.
Dan Richards: We're going to talk about some research that Brandes Institute team has conducted recently, on the role of expectations when it comes to stock market returns. Let's start by talking a little bit about what the long term returns for stocks look like going back to 1920 or so.
Charles Brandes: Yes, well the long term return for stocks going all the way back after inflation has averaged about 6.5% to 7%.
DR: How would that compare to bonds?
CB: The return on stocks would be about 2 or 3 times the return on bonds, after inflation.
DR: Academics look at these results and they say, well, the reason, that stocks outperform bonds is because of something called a risk premium, that because are more volatile, riskier, they demand a higher return. What's your view on the role of risk premium in explaining why stocks outperform.
CB: Well, risk, as the academics define it is wrong. For a long term investor, risk is having to do with how well companies do; the academics define it as just the price changes or volatility. That's true for speculators, prices changes and volatility in the short term, that's risk for speculators, but not for investors.
The academics' explanation for why stocks outperform bonds is not the right explanation. The real simple explanation is that stocks which represent businesses that create goods, they create the wealth that can pay the bond interest. So they have to create more wealth than bonds create.
DR: Talk about the facts that stocks as a whole have outperformed bonds. Now, within stocks there are a couple of different categories; there are value stocks compared to what are called growth stocks. I think you call them 'glamour' stocks. Could you talk about the difference between value stocks and what you call glamour stocks?
CB: Yes, its just a definition of the price that they're trading for, in relationship to the earnings of the company; so again, the glamour stock is the one whose price is high compared to the earnings of the company, because the market is anticipating the earnings are going to grow. They're growth stocks; glamour stocks growth stocks.
Value stocks are where there is very little anticipation of growth, usually, and their earnings are high, compared to the actual price of their stock.
DR: So we've talked about the difference between those two categories of stocks, value stocks vs. glamour stocks. Talk about what the long term performance looks like for those two different kinds of stocks.
CB: If you take those categories and you look at the top glamour stocks vs. the top value stocks, the value stocks over a long period of time will outperform by as much as 5% or 6% per year. In some cases, some periods, you can see them outperforming by as much as 10% per year.
DR: So an academic might look at that and say, well, if you've got a category of stocks like value stocks that outperform to that extent, well the reason must be that they're more volatile and riskier than those other categories of stocks. what's your observation on that?
CB: Well, there's a couple of problems with their conclusions. First of all, they're not more volatile, as they define risk as volatility. So, that is not right. From the other risk standpoint, of how companies do over a long period of time, they're also not more risky. They're actually safer, you're paying for it is a lot less price wise than likewise for future development.
END OF PART ONE
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