Sir John Templeton famously warned in the eleventh of his “16 Rules for Investment Success” that the investor who says this time is different has uttered “the four most costly words in the annals of investing.”1 The legendary growth fund manager was making the point that one needs to be careful of rationalizing why the current environment will end better than a similar one did previously.
Why do we bring up Templeton’s quote from more than 25 years ago? Today, the pace of innovation is changing our lives so dramatically that it can be tempting to think that surely the business landscape is no longer what it once was. And in the past, investors have falsely believed that sharp advances in security prices would continue because of some new development. Even Templeton reportedly conceded that the investor who says this time is different has a 20% chance of being correct.2
Disruptive technologies have indeed threatened a variety of industries, causing some investors to question the idea of mean reversion and whether certain companies or entire sectors can return to prior levels of growth. We consider it our job as an active value manager to differentiate between those industries whose fundamentals are being disrupted from those who are only experiencing stock price disruption. Opportunities can arise if the market overreacts to the threat of disruption and underappreciates a seemingly threatened company’s moat or durability.
Indeed, we think active value management is the most logical approach to investing when disruptive technologies roil the market. Obviously, passive or index strategies pay little heed to secular changes, and smart-beta factors that rely on price-to-book or price-to-earnings multiples to drive stock selection may miss company- or industry-specific nuances.
Cheap vs. Undervalued
Our approach to value investing seeks to determine whether a company is simply “cheap” or whether it is undervalued. With a cheap company, the price has fallen but is unlikely to recover because the company is vulnerable to structural issues. On the other hand, an undervalued company has mean-reverting capabilities, meaning its price has fallen for reasons that may not be long-lasting.
A key tenet of the value approach is to develop a solid understanding of not only the company but its industry and main competitors. This naturally leads us to investigate the specific role technology plays in the company as well as the industry. In each case we ask, is this company and/or industry vulnerable to disruption? Or is there a widespread misperception that may be creating an asymmetric opportunity?
For example, our research teams are wary of the competitive threat that online retailers pose to traditional brick-and-mortar retailers, and we have limited our exposure accordingly. However, not all industries may be exposed to these threats equally. We have found opportunities in a few grocers, especially in the United Kingdom, because online and home delivery companies have not been able to easily disrupt these established businesses.
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