Growth Vs Value Debate

Well, hello and welcome to the first ever investment markets growth versus value debate.

I'm Roger Montgomery from Montgomery Investment Management and I'll be your moderator this evening.

Well, growth and value, that debate is one of the oldest in finance and it matters so much to investors because making the right style choice can be a determinant of your investment success.

Joining me today is Andrew Dale, Portfolio Manager at ECP

Andrew has over two decades of experience in financial services and will be debating for growth investing.

Also joining us and debating for value investing is Steve Johnson, Chief Investment Officer and one of the founders at Forager Funds.

Before we get into it and to set the scene, I've got a couple of quotes I'd like to share with you.

The first one is from Charlie Munger.

He said, all intelligent investing is value investing, acquiring more than you're paying for.

Another one is from T. Rowe Price.

Once a business is well established, the greatest opportunity for gain is afforded during the period of growth in earning power.

Now, I should add that at the 2023 Berkshire Hathaway AGM, which was the last AGM Charles Munger co-chaired before his death in November last year.

Well, he and Buffett were at somewhat of a disagreement about value investing.

Munger said that value investors are going to have to have

are going to face a harder time in the years to come now that there are so many competing fund managers that will diminish the availability of opportunities.

And Buffett countered by saying, what gives you the opportunities is people doing dumb things.

And in the 58 years we've been running Berkshire, I would say there's been a greater increase in the number of people doing dumb things.

A quick reminder of the ground rules.

There'll be three sections to this debate and in each section, both speakers will have five minutes to share.

There'll be some rebuttals of a couple of minutes each allowed in section one and in section three, but no rebuttals in section two.

So without further ado and to get things rolling, let's start section one.

Steve, I'll ask you first, does value or growth investing have greater merit

as a long-term investment strategy and why?

Thanks Roger, and thanks for having me on.

My view is there's nothing about value investing that stops you owning companies that grow.

Value investors estimate how much cash a stock is gonna pay over its life, and then they try and buy that stock at a discount to the present value of those cash flows.

It's as simple as that.

And a cashflow stream that's gonna grow is worth a lot more than one that is going to shrink.

I'll give you a really good example.

In 2012, you could have bought Microsoft for a total company value of 240 billion US dollars.

Just last year, it returned almost $40 billion in cash to shareholders in dividends and buybacks.

That's a 16% return on that valuation of 12 years ago.

Now, any value investor would be happy with that sort of return.

But value investing does allow you to buy businesses that are not going to grow and even ones that will shrink.

if you can buy them at the right price.

I'll give you another good example.

I started my funds management business off the back of the success of an investment in a company called Rams Home Loans.

Now you might remember it was a bit of a poster child of the financial crisis back in 2007-2008 and the New York Times famously called it the worst IPO in history.

Just two weeks after it listed on the stock exchange it had lost all of its funding sources

stopped writing new mortgages and sold that Rams home loans brand to Westpac less than a year later.

All that had left was a $15 billion mortgage book that was certain to shrink as people repaid their home loans over time.

Now my average purchase price in that stock was 20 cents.

It got as low as five cents.

And I remember the date, it was a lot of tax loss selling 30 June, 2008.

The share price here was under five cents.

Over the subsequent five years, that stock paid you more than 90 cents in fully frank dividends, and it was taken over for 50 cents a share, despite its loan book more than halving over that period of time.

Pretty sure even a growth investor would be happy with those sorts of returns.

So value investing gives you the flexibility to buy RAMs at a discount to its asset value, and to buy Microsoft at 12 times earnings too.

And right now we're at the end of a 12 year period where those growing good quality businesses have become very expensive and the flexibility to look elsewhere is going to be very important.

Well, thanks for that, Steve.

Andrew, a chance to rebut.

Yes, Steve, thank you very much for that.

And I'll touch on some of those points in my own presentation.

But I guess the focus for me in asking you a question is like how

How do you take into account the quality of a business and the potential returns that you might forgo if they maybe appear expensive in the near term?

How does one deal with that sort of issue?

Well, I try and accurately forecast that a growth that a business is going to generate.

And I think one of the the models that we have for markets mispricing stocks is that people often have too short a runway on the amount of time that a business can grow for.

You have seen

I'm sure dozens of analyst models over the years that have a company growing for five years and then that growth rate is going to taper off after that period of time.

We've seen with Facebook, Microsoft, Google, these businesses have grown for 20 and 30 years at double digit rates and if you look back at the models, the valuation models that people had 20 years ago, they got it very wrong because they tapered that growth off too early.

So

We put a lot of work into trying to recognise those situations where a company can grow for longer than its current valuation anticipates.

I do think we're in a market at the moment where people are probably being too optimistic in a lot of cases on the other side of the ledger.

All right.

Thanks for that, Steve.

Andrew, you satisfied with that answer?

Yeah, thank you.

Thank you.

Andrew, I'll put the same question to you now.

Value or growth investing, which one do you think has greater merit as a long term investment strategy and why?

Yeah, thank you, Roger.

And look, I think I think it's important to point out here, firstly, that, you know, there's lots of people out there that call themselves growth investors, some call themselves value investors.

But really, what I think differentiates the different types of strategies is the amount of work and focus a person is willing to do on a company in predicting their forward cash flows.

Otherwise, really, we're talking about speculation.

So I wanted to

clear up that investing is really what we're focused on here in our growth.

And I think that when you look at growth investing, what excites me about it is the opportunity to look at new companies or existing that have really interesting opportunities to grow their economic footprints into the future.

We think that the market typically under appreciates the earnings power of some of these companies, you know, these high quality companies.

And as a result, it undervalues the opportunity going forward.

Now, in order to properly pick these companies, however, we do have a requirement for a lot of detailed fundamental analysis, and also looking at long-term horizons in terms of cash flows.

And we've sort of touched on it, but valuation is critical in terms of all of this.

And it is important to avoid overpaying,

But when you look at it from a growth investors perspective, we're not very focused at all on short term PE multiples.

So we're not looking at near term earnings.

One year earnings is absolutely not what we're focused on.

We're spending all our time and energy and doing a lot of due diligence to ensure that we understand five years of cash flows and even beyond.

So growth investing does require good experience.

It does require skill and a willingness and a curiosity to ensure that you can find these companies.

When it comes to growth investing I think that there's often a bit of a misconception in the market that value investing doesn't equal growth investing but both investment strategies actually do rely quite heavily on a value.

Now it just happens that when you're a growth investor you're more focused on that growth component of the cash flows and that's where you put the time in to understand how to forecast these cash flows and bring them back to a present value.

We're more interested in paying for a stock

now with future opportunities to earnings as opposed to thinking about the discount that it might be currently trading at in terms of fair value.

And when it comes to that growth investing the practice itself we've really got two steps that we focus on and why I think that you know investors need to need to be aware of and that is when it comes to stock selection we have to be very focused on the business model of the company

We need to see is it a profitable business model?

Is it growing?

Secondly, we need to be focused on the competitive advantage that the company has.

Are they continuing to grow their market share?

Thirdly, what are the future growth opportunities followed by the management?

Are they high quality?

Is the corporate culture of the organization strong and going to foster growth?

And finally, the financials.

But when it comes to valuation, that's the last piece of the puzzle.

And then that is really something that we after we've assessed the company and understood,

the long-term opportunities, then we can bring it back to value and understand whether there is an opportunity to invest.

And like Steve brought up an example with Microsoft, I'd bring up a similar sort of example and that's realestate.com.

Now, if you'd looked at that back when an IPO back in 2007 was trading on 50 times, most value investors would have found that very difficult to invest in.

However, really high quality business model, extremely strong competitive advantage with market shares above 70%, good growth opportunities,

good return on equity and a management team that have been able to display all of that.

If you look at the business now, still trading on 50 times, which is, you know, equally, you know, would still be considered expensive.

However, over that period of time, it's gone from earning 12 cents a share to $4.19 a share.

So you can see that if you are willing to invest time, energy, do the due diligence, do the industry meetings, management meetings, competitive meetings, et cetera,

you can establish an investment thesis that is supportive for longer term growth.

And I think that's really what we're about.

We want to take, you know, you want to take investors on that journey to because I often think, you know, as a growth investor, how privileged we are to look at some of these new business models and ideas and sort of partner with management in terms of seeing the growth and evolution of those.

But it does require constant due diligence and constant investment thesis testing in order to ensure you're on the right side of

So Andrew and Steve, it sounds to me, and Steve I'll get you to, I'll get you to rebut in just a moment, but it does sound to me that both of you agree that thinking about the future of a company is essential to understanding its potential in terms of the returns that it will generate for you and for your clients through you.

Andrew, I remember buying

I remember buying realestate.com.au at $13 a share with an industry veteran told me that they would be destroyed by the entrance of Google coming in and taking away their market.

And I think you're absolutely right that if you get the growth right and the growth is produced, the purchase will ultimately be something that Steve would agree with his good value.

And 50 times earnings

20 years ago is cheap today.

Yeah.

And I think I think the point there, Roger, is a Google executive talking about it is the kind of thing we try to get away from.

We're focused on this was a real estate agent who was worried about Google.

Yeah, I think that the where people kind of miss real estate was there, how integrated they were to those real estate agents, how much they became part of the model.

how much their vested sort of interests helped to grow the model.

And look, honestly, over that 15-year period, we would have undertaken hundreds of meetings to properly assess, understand, ensure, you know, domain coming in, etc.

So yeah, I mean, I think, you know, as Steve said, you know, you

we all have to look into the future for these companies.

So it's absolutely critical.

So Steve, REA has probably one of the most valuable competitive advantages around and that is the ability to raise price without a detrimental impact on its unit sales volume.

Thinking about that through a value lens, how would you rebut some of Andrew's comments?

I certainly will rebut that example.

I think it's been one of the great growth and value stocks.

You know, you look at the cash that that business is generating

relative to where you could have bought it 20 years ago, it has been one of the great investments.

I think a couple of things to be really careful about, though, for people to recognise, we're all saying we do valuation.

With an RHG, all of that cash flow has come back to you in a period of five years time.

You don't really need to worry about what the world looks like 10 or 20 years down the track with any of these growth businesses where you pay a high initial multiple of the company's earnings.

A lot of the valuation of that business is what cash it's going to be generating 10, 15, 20 years down the track.

I actually agree with Andrew.

That's a very interesting exercise to try and solve.

the world is also a very very uncertain place and when you've got all of that value tied up in what you know bonding investors would call a long duration asset it doesn't take much to go wrong for your valuation of that business to be very very wrong and the other thing just from a pure valuation perspective I'd be careful about is low low discount rates you see I think with a lot of growth stocks as the price goes up and people want to keep owning it they justify it with

Well, we now want an 8% return from this stock.

And if you start plugging 8% required rates of return and 7% growth into DCF models, you start getting some pretty crazy answers.

I did a bit of that in my.

early years at Macquarie building spreadsheets that you start getting very, very big changes in valuation for a pretty small change.

Yeah, and I think we'll address that when both of you talk about the outlook.

I think that's something both of you could refer to.

It does sound in all of your comments, though, I have to confess, it sounds like you would both agree that in the short run, investors have a tendency to overestimate the future, but in the long run, perhaps underestimate the future.

Would that be right?

Andrew?

Um, look, Roger, I think that I think that's a little bit of an element of speculation, frankly, like short term, firstly, we're talking long term here.

And then that's how we approach things.

So, you know, we were looking at five and even 10 years of cash flow.

So, frankly, often things like reporting season, we consider them to be really good times to get data points and interact with management, but but they're not the focus.

We're focused on that three to five years of cash flows to start with, and then beyond.

I think I'm saying I guess, Andrew, I'm talking about the estimates for the first three years.

Yeah, look, I mean, there's no doubt brokers and speculation people out in the market tend to be, you know, and it depends on the macro environment when things are great.

When things are bearish, everyone's cutting to the bone.

And, you know, I think that, you know, and I've heard you talk before about, you know,

very much getting rid of that noise of mine pollution, I like to call it.

You know, you absolutely want to stay away from the noise because you need to bring it back to fundamentals and focus on what is really driving the value of the stock.

And I think that's always going to be critical because short-term's a roller coaster.

Steve knows that as well.

I think as well, Roger, in that point, really in the growth space, trying to understand

He touched on the competitive environment.

Also what the addressable market is.

I think some of the great opportunities have been people underestimating what that addressable market is.

And it happened with a real estate.com because people said, well, it costs you 200 bucks to put an ad in the paper.

They're going to make $200 per house.

And that was the model.

Once it's penetrated, that will be the end of the addressable market.

We've seen with Google, we've seen with REA, they actually expanded that addressable market quite dramatically.

in the new world.

And now you look at it and you go, well, someone's selling a house for a million dollars.

They can't really sell it without advertising it online or the risk of them losing 50 or $100,000 of sales value is very high.

Therefore, they can charge $5,000, $10,000 for you to sell your house through their platform.

We've seen the same thing with car sales.

They're up to almost $1,500 a car.

Your average dealership's only making $4,000 a car.

Car sales is taking 30, 40% of the gross margin that is available there.

And people massively underestimated how long and how big that runway was.

Again, I think these examples can lead people to think that it's easy and it's always very easy to say, oh, this addressable market is going to be huge and this company is going to keep growing.

In most industries and most companies, the competitive response is stronger than we have seen in those examples.

Well, thanks both for those comments.

It's been excellent.

I'm trying to keep us on time because it's such an exciting topic to be talking about for investors.

We'll move on to section two.

No rebuttals in this one and we might keep it to three minutes each.

I'll start with you, Andrew.

Has being a growth investor helped you outperform over the long term?

Roger, yes, the answer simply is yes.

If you would look at the chart on screen, you'll see the ECP Growth Companies Fund, which is, you know, gives you an idea since inception of the performance.

And I think that chart itself pretty easily highlights how we've gone through that period.

And I would say if you would actually take that and break it down a little bit further, it really comes back to fundamentals have driven that long term return.

Short term,

You can see on the next chart, you know, the movement in stocks can often be driven by changes in valuation multiples, which accounts for a lot of the changes.

But when you look at the right hand chart, which is the longer term period and the breakdown of returns for the portfolio, you can see that it's been heavily influenced by earnings growth and dividend income and PE multiple expansions very little.

So what that's trying to say to you or investors is that

Looking at fundamental stocks, growth stocks, high quality stocks that perform over the long term do contribute really positively to the portfolio.

And that's what we've seen in our returns.

And that's why we're, you know, personally, I'm really a big proponent of growth because I think that you can, with the right stock selection, do very well.

And Steve, your thoughts.

Have you outperformed as a consequence of value investing or as a in terms of reward for value investing?

I mean throughout my life being a value investor has generated enormous outperformance for me.

I bought a business when I was 25 years old and have never really been paid a market salary and I've accumulated really all of my wealth outside the business through investing.

I've never really done the calculations but enough massive winners to set my investment portfolio up for life.

We set our funds management business up in 2009 though, and I would actually say it probably hasn't helped over the past 14 years.

We started in 2009 holding growth stocks has been pretty much the only game in town for most of that period.

We've managed to outperform in our Australian fund and outperformed before freezing our international fund as well.

But I'd almost say a disciplined value-based philosophy has been a disadvantage in this fairly unique period.

We've also refined the way we apply that philosophy over recent years with almost 400 million under management today.

The days of buying those Segarba stocks are behind us.

More emphasis too on how much cash is actually going to come out of the stock rather than just how much will be generated in it.

listed company directors and company management, I'd say they're generally not good investors.

And one of the great things about those growing companies that Andrew likes is they don't need to think too much about what to do with the profits, just reinvested in what you're already doing.

And that takes that investment expertise out of the equation, it can be helpful.

So

Whether a company's growing or shrinking management and board teams, they tend to try and do things to fix the problems in those shrinking companies.

So we spend a lot of time now thinking about that and trying to incorporate that into our valuations.

But buying when expectations are low is what we do well.

It's been a great north star for us over several decades and will continue to be so in future.

Well, let's talk about the future, Steve.

We'll start with you.

I know we're not in the business of predictions and forecasting.

We don't have crystal balls that are reliable.

But let's look at 2025 and beyond.

Do you think value investing or growth investing is going to outperform?

I think you've heard from both of us today that

we're hopefully more adaptable than just one factor.

And I certainly don't have any insight into the time.

I do think we're closer to the end than the beginning of this great growth era.

One of my good friends is very, very good investor, a fund manager as well.

And one of his favourite stocks is PWR Holdings.

It's been a great Aussie success story and it's a wonderful business.

And he was explaining in his report how that company had doubled its profits over the past five years.

The share price is up eightfold, so way more than half the gain in that example has been via multiple expansion.

I think at the very least that multiple expansion has run its course and particularly if interest rates stay closer to current levels rather than zero.

So your future returns will be limited to earnings growth at best.

It can be worse than that.

The 12 years leading up to 2012, that Microsoft example I used earlier, it increased its earnings fourfold over that 12-year period, but the multiple fell from 50 at the peak of the dot-com boom to 12 in 2012.

And the share price went nowhere over that period.

So that was the end of what was a great period for value stocks.

And at the end of that period, everyone was publishing papers and saying, look how well the value factor has done.

And I think it was such a momentum thing

growth stocks that actually become value because of the underperformance over that period of time.

Look we've all learned some very important lessons about appropriately valuing growing businesses over the past decade and to paraphrase the late Charlie Munger who you mentioned earlier it's hard to pay a low enough price for a business in decline.

I think it's often true in investing though that you learn that the right lesson at the wrong time to be applying it and I do think we're near the end of what has been a wonderful era for growth stocks in general

And if we as value investors can keep generating those returns of 10 to 15% over the next decade with a really disciplined focus on cash flows, I think that'll lead to some very significant outperformance over that decade.

Well, thanks for that, Steve.

I'm conscious of time, Andrew.

So perhaps in your response to what the outlook looks like for growth stocks, you could rebut some of Steve's comments.

Yeah, look, I think, you know, Steve hit on some interesting points.

And I'd also probably say that, you know, there's a real important distinction with what both Steve and I do, and that is that we're active investors.

So we're in the market of whether valuations are high, low, growth's high or low, value, etc.

We're actively involved in picking stocks to determine which ones are right at the right time.

So for example, growth expensive is a bit of a throwaway statement.

as opposed to there are individual stocks within growth that look interesting.

So I think that's an important point.

But when it comes to the outlook, I think what's really clear from a macro is I've got no idea.

There's global economies, there's wars, there's China.

I mean, China's a huge factor at the moment in terms of its impact on Australia and other parts of the world.

None of these areas and forecasts are we going to get right.

That's just not our business.

So we have to bring it back to bottom up.

which is what we're focused on, bottom up fundamental analysis on high quality businesses.

And I have no doubt that over the next one to two to three years, that growth environment will continue to show ideas, opportunities, et cetera, that will enable us to find good companies that will generate good economic returns and hence performance.

So I think all investors need to retain that curiosity, that interest level,

the willingness to do the work in order to help understand, identify these opportunities because they always exist.

And active investment is really the role of trying to unearth those and take investors on that journey.

I think from a value just in rebuttal to Steve, I think that the biggest challenge, regardless of the direction of broader markets going forward, is how do you sort of leave certain stocks on the sideline that may optically appear expensive?

but generate those huge returns over the next 5 years.

It must be more of a challenging decision.

And I'm curious as to know, because obviously, Steve's a smart individual, and he knows when a company is good, but when the value is not right, how do you actually step away and say, you know, that's not for us?

That's an interesting one, Steve, that Andrew's left you with.

We know that if we can find a business that generates, let's say, 20% EPS growth and its PE remains constant, you're going to get a 20% IRR.

So if the PE doesn't change, your return equals the earnings per share growth rate.

How do you answer Andrew's question about that?

A company that's growing strongly,

It might have a high PE, but of course if that PE doesn't compress, it may not become good value.

You're happy just to ignore that?

Yeah, I mean as a starting point, my job here is to generate people double digit rates of return and I think if we can successfully do that, our fund can play a really important

role in their portfolio irrespective of what happens elsewhere.

We need to do what we do well well and sticking to it is even a short focus of mine.

I will say even taking an REA for example you know at 50 times earnings 20 years ago when you had

all of that growth ahead of it.

I think it's very, very different from 50 times earnings today.

You are not going to 20x the earnings of that business over the next 20 years again, otherwise you're taking $300,000 per house here in Australia.

So I do think we've got to a point, those stocks, those high multiple stocks, they should de-rate as they mature and people need to be aware of that.

And look, I think there's just an enormous easy sleeping opportunity in some of the boring value stuff out there.

It's truer overseas than it is here in Australia, but we own some, we own Tesco in the UK, for example, that stock is paying dividends of 6% a year.

It's buying back 6% of its stock.

It's growing in line with GDP.

So you get 3%

earnings growth, they buy back 6% of their shares every year.

So the earnings per share is growing at 9% a year, you're getting 6% in dividends.

It's actually just a really simple investment to sit there and own.

And I know the whole argument, nobody's ever going to like it.

And you get all of those arguments at the end of a wrong period.

But I think those returns, given where today's overall market is valued, are going to be very, very acceptable for the foreseeable future.

Well, thanks for that, Steve.

That brings us to the end, and thank you, Andrew, by the way, that brings us to the end of our growth versus value debate.

I've certainly taken away a key, I think a key takeaway for me is that, gents, that in both cases, there's a lot of work that needs to be, there's one, there's a lot of ways to make money in the market.

That's the first thing.

And you can find that one,

feels better perhaps or you have more of an affinity with one style to another.

But in both cases, you've both demonstrated that you have to put in a lot of work to understand the business and to understand its earnings potential or its cash flows over the next number of years.

I hope you've enjoyed the debate today and if you've got any questions, please send them through to events at investmentmarkets.com.au.

I've really enjoyed listening to Andrew and Steve talk about what they do and what they do so well.

I hope you have too and we look forward to talking to you again soon.