When investors think about investing in quality, they often think of it as a factor, but it’s more than just a factor. According to Rich Pzena of Pzena Investment Management, value investors need to think about quality and valuation when looking for stock to buy.
In an interview with Raul Panganivan of Value Walk, Puzena talked about the value cycle and value stock, the importance of considering quality in value stock, and more.
- 1 Value cycle
- 2 Possibility of tailwind for value stocks
- 3 Inflation and value stocks
- 4 The importance of quality
- 5 Incorporation of ESG
- 6 Risk and avoidance
- 6.1 AlsoRead
- 6.2 The PitchBook Economy
- 6.3 A Smart 6% Dividend Strategy For The Omicron Era
- 6.4 Billionaire Hui Ka Yan Gets Help From Guangdong Government Amid Evergrande Debt Crisis
- 6.5 Bitcoin Prices Fell To Almost 2-Month Low—What Should Traders Expect Next?
- 6.6 Dow Jones Industrial Average Sees Four-Week Losing Streak
- 6.7 Can You Actually Lose Money On Your Employee Benefits?
When asked what part of the value cycle he was in, Pzena said that the value cycle can occur for a variety of reasons, most notably the business cycle. When the economy is sluggish, the performance of circulating stocks tends to decline early in the recession. However, this time it was different because the economy shut down overnight and the management team responded much faster than would be seen in a normal business cycle.
“Looking at the duration of the value cycle, the good side tends to work and the bad side is a mirror image, so when the situation begins to improve, management is still uncertain whether it will really be available. It takes time to get the cost back, so it often tends to extend the value cycle over the years because you don’t know what will happen. “
As the global economy recovers, revenues will rise faster than costs, astonish people and generate revenue momentum, so margins should grow.
“The typical value cycle linked to the business cycle lasts for quite some time,” Puzena said. “… Momentum stocks in the market will be the same stocks as value stocks. When the business cycle is delayed, people don’t really understand it. Momentum stocks are growth stocks. But today we have the next two years Looking forward, you took the universe of valuable cheap stocks and saw their earnings growth forecasts, even our consensus forecasts, but in the next few years the growth rate will be higher than them growth It’s for stocks. If it works, it tends to lengthen the business cycle. “
Possibility of tailwind for value stocks
Pzena believes it is in the early stages of the cycle for a variety of reasons, including long interest rate cycles. Lower interest rates raise the valuation of growth, so once interest rates stop declining, some of the tailwinds of growth valuation disappear.
“If you look at the cheapest stocks today and compare them to the highest stocks, the gap is wider than ever,” said Puzena. “We saw something comparable only during the dot-com bubble 20 years ago.”
Today, there is almost unlimited capital to fund almost all types of investment ideas with great potential. But Puzena believes that the flow of capital will be depleted, with a tailwind for “boring and valuable companies” to invest in, rather than “exciting growth stocks that everyone has become accustomed to in the last two decades.”
Inflation and value stocks
Asked if inflation would help invest in equity value, Puzena said it was unpleasant to say anything other than the truth. But Rich believes that without results and inflation, it is hard to believe that there could be so many exciting monetary policies worldwide.
“There are several ways in which inflation can affect value stocks in particular,” he said. “One is through the back channel of interest rates. Therefore, if interest rates rise, they are generally not at all good for the market because of the inflationary environment, but worse for growth stocks.”
Pzena added that investors must hold shares for the rest of their lives and can build portfolios that cannot be sold. Equities should have a cash flow flow based on a reasonable and rational view of futures. According to Pzena, it’s impossible to generate double-digit returns without raising the valuation on cash flow alone. But now it’s not easy to do that in most markets.
“Remember that equities are better than fixed rate bonds because there are no offsets. At least companies have the ability to raise prices to offset inflation, and some are now. We see what’s happening, so inflation doesn’t have to be bad for stocks. It’s bad for valuations, but it doesn’t have to be bad for the profits of these companies. “
The importance of quality
Pzena states that there is a difference between investing in quality and avoiding poor quality. To invest for quality, you have to pay a higher price. Puzena was always looking for a “superbly high quality, cheap business”, but that didn’t happen. Rich adds that if you look only at the price and ignore the quality, you can get burned. Pzena states that part of the evolution of his investment process focuses on potential investment quality.
“After the investigation of Benjamin Graham and Dodd, I would have said I did it when I was in school,” he said. “You can buy anything as long as the company doesn’t lose money. If it’s cheap enough, it’ll work today. I think some companies can destroy capital over time. And I want to get rid of them, so that’s me. It’s a fundamental part of our approach. “
Incorporation of ESG
Pzena considers ESG to be an interesting concept. This is because some businesses are related to the environment, while others are related to governance and social change. He says these factors are always part of his process.
“Perhaps thirty years later, we can’t invest in oil stocks without the fact that we don’t use oil,” Puzena said. “It’s impossible to think about it. So it was part of our process from the beginning, but we never called it ESG.”
Rich explains that he is not investing in ESG, that is, he is investing in companies that drive social and environmental change. Pzena states that this is a growth stock business model, not their expertise. Instead, invest in companies whose assessments reflect their environmental, social, or governance impacts. They are also looking for companies that are working to improve things.
“The data is unconvincing, so you need to take it with a grain of salt,” says Pzena. “It’s not long enough to draw statistically significant conclusions, but it can be observed, and companies that improve ESG rankings actually invest more than companies that already have high ESG ranks. It turns out to be a reliable place … buying a company Even if you start from a low quality perspective, you are actively making changes to your business to become a better player, or the base is actually a value philosophy It is very consistent with. “
Risk and avoidance
Panganiban asked Pzena what areas are at highest risk today and what he was avoiding. Pzena believes that the biggest risk lies in “a high-flying company that builds its business from the capital it raises … and has a dauntingly high reputation.”
“On a daily basis, you see companies that are 30 times more profitable and less profitable,” he explains. “I think these companies have a lot of risks from a stock perspective. There are risks from a macroeconomic perspective, there are always risks to rising interest rates, and corporate management is well managed. think.”
Pzena adds that government action is also an investment risk. This is one of the reasons why our global portfolio is diversifying, and while these risks exist, we are not focusing on any of them.
“We think we are in a significant part of the value cycle from a cycle perspective,” he said. “So if you define …