Hailed by The New York Times as a "guru to Wall Street's gurus," value investing expert Bruce Greenwald takes some time to offer his insight and advice to The Motley Fool. A professor at the Columbia Business School, Greenwald has also authored Value Investing: from Graham to Buffett and Beyond and Competition Demystified: A Radically Simplified Approach to Business Strategy.
Greenwald takes on GMO chief investment strategist Jeremy Grantham's ideas on the sustainability of profits and reversion to the mean. He explains why the shift toward a service economy may make for more sustainable profits than some investors think.
Full transcript below.
Matt Koppenheffer: Thanks for joining us, Professor Greenwald. This is a great opportunity.
We were actually in town for the Value Investing Congress, and it seems like one of the themes that was running through the Congress is that there had been value available all over the U.S. market, and now that's sort of disappearing. Have you seen anything similar?
Bruce Greenwald: I think that is pretty much a universal theme. How long it's been a theme, and how novel it is, depends on how you read the level of profits in the economy.
If you are Jeremy Grantham and you believe in regression to the mean, profits are currently about 14-14.5% of national income. Historical norms are 9%, so that would mean we're talking about profits being inflated by a third.
If we've got pretty much normal multiples, which are 15-16 times forward earnings based on current projections, and those projections are 40% overestimated, you're talking about 20-plus multiples to sustainable earnings. If that's the case, then we're in for a world of hurt, and there really is no opportunity.
But having said that, I think -- and you've got to remember, I think Jeremy has been wrong about the reversion to the mean for about eight years now -- and I think that there are structural reasons to believe that profits at or near this level may be more sustainable than he's giving them credit for.
The reason for that is that, as we move to a service economy, what you've got is a lot more markets where goods are locally produced and locally consumed. Those are, by their nature, small markets. Small markets are dominatable.
It's very hard to dominate the global automobile market. It's a big, global market. Anybody who can get 3-4% share can be viable in a global market. There's no way you're going to keep people out at that level.
If you're talking about local grocery stores -- where you've got economies of scale and distribution, you've got a lot of high turnover and low-cost workers, so you've got big economies of scale and management, and an advertising that's at fixed cost -- you're not going to be viable in most of those local markets unless you get a 20-25% share.
That means much more of the economy is in markets with significant barriers to entry, and that means significantly higher profits that are protected by those barriers to entry.