At the Money: Stock Picking vs. Value Investing with Jeremy Schwartz, Wisdom Tree. (February 7, 2024)
Full transcript below.
About Jeremy Schwartz:
Jeremy Schwartz is Global Chief Investment Officer of WisdomTree, leading the firm’s investment strategy team in the construction of equity Indexes, quantitative active strategies, and multi-asset Model Portfolios. He co-hosts the Behind the Markets podcast with Wharton finance Professor Jeremy Siegel and has helped update and revise Siegel’s Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies.
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TRANSCRIPT: Jeremy Schwartz Value Investing
Barry Ritholtz: How much you pay for your stocks has a giant impact on how well they perform. Chase a hot ETF or mutual fund that’s run up, and you might come to regret it.
I’m Barry Ritholtz. And on today’s edition of At the Money, we’re gonna discuss whether value investing should be part of your strategy. To help us unpack all of this and what it means for your portfolio, let’s bring in Jeremy Schwartz, global chief investment officer at Wisdom Tree Asset Management and longtime collaborator with Wharton professor Jeremy Siegel. Both Jeremy’s are coauthors of the investing classic, Stocks for the Long Run.
Let’s start with a simple question. What Is value investing?
Jeremy Schwartz: Value investing, we define as really looking at price versus some fundamental metric of value. Our our favorite ones are dividends and earnings.
You say, why do you buy a stock? Present value of future cash flows, any asset is present value of future cash flows. And Stocks, those cash flows are dividends. Dividends come from earnings, and so those are sort of anchors to valuation.
And, you know, it’s a critical component. Judging a stock based on what it produces to you as an investor.
Barry Ritholtz: So last time we had you on, we discussed stocks for the long term. What advantages do you get from investing with a value tilt over the long term?
Jeremy Schwartz: You know, I think 1 of the big risks to the market are these major bubbles. It’s where tech bubble in 2000 is the classic example. And, you know, Siegel had long been just a Vanguard buy and hold in stocks for long run. He gave Vanguard a lot of free publicity. He was saying buy the market, buy cheaply with index funds.
Until the tech bubble where we started talking about this massive overvaluation in sort of these big cap tech stocks.
Barry Ritholtz: He had a very famous Wall Street Journal piece In, like, late night fourteenth 2000. So days before the bubble popped.
Jeremy Schwartz: And basically said that there’s huge Tech stocks, triple-digit PEs, you can never justify the valuations no matter what the growth rates are. So his own portfolio started selling the S&P 500 and buying value.
And his second book, The Future for Investors, was all about these strategies to protect from bubbles and be a valuation-sensitive investor. And that’s where he focused a lot on dividends, a lot on earnings, and strategies that sorted the market by those factors to try to find the cheapest stocks on those fascvtors.
Barry Ritholtz: So professor Siegel very specifically said, don’t focus on the short-term price movements. Instead, focus on the underlying fundamentals of the business.
Jeremy Schwartz: Yeah, and we we tell a story in the book, Future for Investors – even now in the news and stocks for a long run of IBM versus Exxon – And there are 2 very interesting So they’ve been around for decades. So we look back 70 years of returns, and you look at the growth rates of IBM versus Exxon over the last 70 years. And you say, IBM beat Exxon by 3 percentage points a year on sales growth, 3 percent on earnings growth, dividend growth, book value. With any growth metric, It wins over all long-term time periods.
But then why was Exxon the better return for the last 70 years? And it’s interesting. Like, Exxon sold At a 12 PE, IBM sold at a 22 PE on average. 1 sold at a 2 percent dividend yield. 1 sold at a 5 percent dividend yield. Right?
So You had Exxon being the classic value stock, IBM the classic growth stock. I think of that largely like the market versus high dividend or value investing state. The S and P is Around 20 times like IBM was, it’s below 2 percent yield. High dividend stocks are like a 5 percent yield and 10 PEs.
So it’s really this sort of valuation-sensitive approach, but people get too optimistic on the more expensive parts and too pessimistic on the value segments.
Barry Ritholtz: So how should we measure value as an investor whether it’s picking out individual stocks or buying broad indexes? What’s the best way to think about value?
Jeremy Schwartz: I mean, the real risk to value, are you buying these value traps where the price is low for good reason. Right.
They’re forecasting that fundamentals aren’t sustainable and you never know that with a single stock. And so that is where We talked about diversification and buying index funds for the whole market is a very sensible way to do it. Even for these value strategies, you can get rules-based discipline strategies of hundreds of stocks that get you that type of value discipline, whether you’re looking at things like high dividends that we do at Wisdom Tree, other factors that you can sort by. Idea is getting a broad diversified portfolio, not trying to buy a single cheap stock.
Barry Ritholtz: So for people who are trying to wrap their head around the typical value investor, give us some examples of famous value fund managers who put this into practice.
Jeremy Schwartz: It was interesting. When we first I talked about “The Future For Investors” and we started working on that. Siegel suggested I go read everything Warren Buffett had ever and The time Buffett was coming out against the tech stocks too back 20 years ago and saying these
Barry Ritholtz: I recall people saying, oh, this guy’s passed his his prime. He’s done. You could put a fork in Warren Buffett. Exactly.
Jeremy Schwartz: And so we were reading every letter he’d written and, you know, it’s interesting Buffett’s own involvement from being a Ben Graham style Oh, buying just cheap price to book stocks, what he called cigar butt investing later on is getting glass puffs of these cigars that were through cheap stocks at their very last moments Towards actually morphing towards a quality investor and and buying Apple as one of his flagship companies now. And I do think over time, they found buying these high-quality businesses at fair value prices is also part of the value investing framework. But he’s definitely 1 that we looked up to and tried to model a lot of our thinking of what is value investing off of this high-quality franchise businesses too.
Barry Ritholtz: You could do worse than Warren Buffett. And I recall When he was first buying Apple, it was trading at a PE of, like, 12 or 13. Very reasonable for what the company later became.
Jeremy Schwartz: Yeah. Now it’s around 30 times not having the same growth rate as it used to, but it still has these huge valuable franchises. And they consistently grow their dividends, they do buybacks, they’re doing the types of Kearney cash to shareholders approach that he likes.
Barry Ritholtz: So we’re recording this towards the end of 2023. Growth has done really well. What makes value more attractive than, let’s call it, growth investing?
Jeremy Schwartz: You know what? We talk about the long-term benefits To value, but the last 15 years have been a very painful stretch to be a value investor. It has definitely been a 15-year stretch Hallmarked by growth until 2022, and then you had things like the Nasdaq down a third and high dividend stocks positive. Okay?
Now it’s reversed again entirely this year in 2023.
Going forward, you know, what’s driven growth, Things like Apple that you said were seeing, you know, 12 PEs. Microsoft, they had they had very low PEs and then they had above-average growth and expanding multiples. So we had two tailwinds: Better growth, multiple expansion.
It’s gonna be hard for them to have the same multiple expansion ahead. And so then the question is all comes down to earnings growth. Can these big tech stocks keep growing earnings much faster than the market? That’s the real question, and they’re very big, and so then, we’ll see if they are able to keep their moats for some time, um, but often when you get these high multiples, earnings start to disappoint and that’s when the corrections come.
In value, you know, high dividend basket at 10 PE, a 10 percent earnings yield. You don’t need real growth. You’re just getting the return. 10 percent is a very good return [Sure]. In real cash flows. And so I think that is a basket that I think, uh, I’m very optimistic on over the next 10 years.
Barry Ritholtz: So I hate when people blame Bad performance on the Fed, but I can’t help but wonder: 15 years of outperformance by growth investors coincided with very, very low rates. Suddenly, the Fed normalizes rates. Maybe it was a little quickly, but rates are back up to over 5 percent — seems to be a period where value does better, when capital isn’t free. Any any truth to that?
Jeremy Schwartz: It’s very interesting. And there’s there’s some debates back and forth. I have Cliff Asness saying that interest rates haven’t been a factor for value as a cycle. Professor Siegel’s talked a lot about The duration with these high expensive growth stocks are being more like long duration assets and that raising rates should impact The valuations of the the high highest gross stocks.
It’s fascinating: A lot of the traditional relationships are flipped on their head. I thought of small caps as benefiting from a stronger economy, you see rising rates good for small caps. But small caps today are trading the opposite of rates where, you know, they have the most lending that’s tied to floating rate instruments. They don’t have debt, so they’re borrowing from banks and using bank loans. So they’re like the only people facing the cost of these higher rates as they’re paying more interest on their bank loans. And so when rates have been falling over the last few weeks, small caps have been outperforming or doing much better.
So a lot of traditional relationships have been challenged this year, but I think we come back to valuation drives return over the very long run. So when we think about small caps at 10 to 11 PEs, High dividend stocks at 10 to 11 PEs, that we think will really matter over the long term and not just the Fed and the interest rate Situation.
Barry Ritholtz: So let’s talk exactly about that basket of stocks with a 10 PE versus a growth basket with a 30 PE. I like the idea of a pretty fat dividend yield and that low PE. Sometimes in the past, we’ve seen high-dividend stocks have their yields cut. What sort of risk factor are we looking at with these low PE high dividend stocks?
Jeremy Schwartz: Yeah. It’s absolutely true. You know, a 30 PE was is just a 3 percent earnings yield. Those companies are expected and will grow their earnings faster than the high-dividend stocks. There’s no question they’re gonna have faster growth rates.
Question is can they maintain the growth rates that the markets really do expect? And so that’s where there’s the the higher the PE, the more the expectation, the harder they fall when they disappoint over time.
But there is this value trap sense, you know, are you buying just stocks that may cut the dividends? We tried to screen for things that could have sustainable dividend growth and, negative momentum is does the market know something that the fundamentals haven’t reflect, it’s not in the earnings, not in the dividends yet. Sso you try to screen for that. But in general, what we find is Over very long periods of time, the market overly discounts the bad news and sort of they become too cheap, uh, over a long period of time.
Barry Ritholtz: So what you’re really driving towards is expectations matter a lot. High PE stocks, high growth stocks have very high matter a lot. High PE stocks, high growth stocks have very high expectations, and they can disappoint just by growing fast but not fast enough.
And yet we look at these value stocks that are often overlooked, and they have very low expectations.
Jeremy Schwartz: Yeah. I think that’s the classic case for, like, Novidia today, which is 1 of the highest Multiple stocks in the S & P, they’ve been delivering. They’ve been 1 of the best growth stories you’ve ever heard, you know, continuing the the AI revolution. But Can they keep delivering this record growth rates? It’s gonna be tough for them.
Barry Ritholtz: We saw the last quarter. They had great numbers, not great enough.
Jeremy Schwartz: Yes, they haven’t quite broken this new all time high level. It’s a classic case of it’s just gonna be tough for them to keep delivering on these very elevated growth rates.
Barry Ritholtz: So if an investor is thinking about managing risk and having a margin of safety, you’re obviously saying value is the better bet than growth.
Jeremy Schwartz: Value and small caps today. Both you can get 10 to 12 times earnings. High dividend stocks, I think, are 1 of the cheaper segments of even within the value portfolios. High dividends have been Especially cheap today.
Barry Ritholtz: So we’ve been talking about risk. We’ve been talking about volatility. We haven’t talked about performance. What are, if any, The value advantages over the long term, regarding performance.
Jeremy Schwartz: We done some studies back to the S and P 500 inception in 1957, when we look back over that, you know, 60ish years, the most expensive stocks lag the market by a hundred to 200 basis points a year. The cheapest stocks outperformed by 200 basis points a year. And so these are compounding over 60 (not quite 70) years, but very long term periods, uh, and so that there is a a substantial wealth accumulation that comes with a 1 to 2 percent year advantage or a lag.
Barry Ritholtz: So to wrap up, investors who concentrate more in value indexes tend to have less Volatility and lower risk than stock pickers and other investors do, and long term value investors also have the potential to generate Better returns. I’m Barry Ritholtz. You’re listening to At the Money on Bloomberg Radio.