Return of the Long-Term Value Cycle

Data found by Whitney Tilson suggests that value investing, having returned to favor after the bull market madness of the late 1990s, will continue to prove successful for many years to come. In this article, Tilson discusses five strategies individuals should consider in such an environment -- including getting out entirely if you are not confident in your ability to outperform.

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By Whitney Tilson
September 18, 2001

I believe value investing, having returned to favor after the bull market madness of the late 1990s, will continue to prove successful for many years to come. That I would think this is perhaps unsurprising, given that I am a value investor -- as Warren Buffett once said, "Don't ask a barber if you need a haircut" -- but I have recently found some interesting data that supports my argument.

The following table breaks up the years since the beginning of 1969 into eight periods: four in which growth investing dominated and four in which value investing did. (Value stocks are defined here as the 200 stocks among the largest 1,000 that have the lowest price/book ratios.)

Here's the data for each period:

               S&P 500  Value Stocks 
Date Months Return Return Difference

------------------------------------------------ 1/69-6/73 54 19.3% -8.3% 27.6%
7/73-7/79 73 30.4 206.9 176.5
8/79-11/80 16 45.6 17.4 28.2
12/80-11/88 96 160.7 414.7 254.0 12/88-10/90 23 25.1 -16.2 41.3
11/90-8/95 58 113.2 247.9 134.7
9/95-2/00 54 163.0 71.8 91.2
3/00-7/01 17+ -9.9 47.4 57.3

CAGR* 1/69-7/01 12.1 17.4 5.3
*compounded annual growth rate

Source: Richard Pzena, Pzena Asset Management

This data suggests some interesting things. First, value investing has produced superior returns over long periods of time. Second, note that the average time in which growth stocks dominated was a mere 37 months, whereas when value stocks returned to favor, they remained in favor for an average of 76 months. If we apply this average to the current value cycle, which is only 18 months old, it would imply that value investing will remain in favor for approximately five more years.

Five more years. That makes a mockery of the claims -- prior to last week's terrorist attacks, anyway -- made by CEOs and market gurus who are predicting that stocks, especially in the beaten-up tech sector, have reached a bottom and that sunny days are just ahead. Investors should be prepared for just the opposite, regardless of what happens in the markets this week.

I've been suggesting that investors sell their overvalued tech and Nifty Fifty stocks for some time now.  Despite the decline in such stocks, however, I'm not changing my tune: For many such companies, fundamentals stink and valuations are still very high. Don't let what happened last week keep you from considering these concepts.

Think stocks can't fall any further? Look at what happened to Manugistics (Nasdaq: MANU) two weeks ago -- only days after I warned readers (again) about this stock -- upon announcing a larger-than-expected earnings shortfall. The stock may have looked cheap at $11.50 per share two weeks ago because it had fallen so far from its 52-week high above $66, but now it sits around $7.

Reduce expectations
It's time to face the reality that the market isn't likely to come roaring back anytime soon. Sure, there might be bounces such as the ones in April and May of this year -- and who knows what will happen in the aftermath of the terrorist attacks -- but over a longer period I think the prediction Buffett made in his brilliant November 1999 Fortune article will prove correct. He wrote:

"If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate -- repeat, aggregate -- would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more."

This article is a must-read.

Strategies for success
Investors who ignore valuation and buy stocks trading at rich prices will continue to pay dearly. While this type of investing works brilliantly for short periods, long-term value cycles reward the following timeless investment strategies:

  • Don't let cash burn a hole in your pocket. There's nothing wrong with earning a guaranteed 3% or 4% annually, especially if the alternative is losing a lot of money quickly.
  • Insist on an extra-large "margin of safety" (a phrase coined by Ben Graham in the greatest book ever written on investing, The Intelligent Investor). Maybe during the bull market you were willing to invest in stocks that you felt were 20% undervalued. Perhaps now you should bump that to 50%. Put another way: If you can't find investments that leave you trembling with greed, don't invest!
  • It's easy to get caught up in the excitement concerning a stock's potential upside. Don't! Instead, spend 80% of your time analyzing the downside risks and only invest in situations in which you think the odds of losing money are small.
  • I never cease to be amazed at how many people hold onto the stocks of crummy companies in the hopes that they will rebound (usually to the price at which they were bought, so they can be sold without embarrassment). Don't fall into this trap.
  • If you don't know exactly what you're doing, sell your stocks immediately and don't invest in individual stocks again until you do. Investing is not a lark. It's a serious and -- as so many unsuspecting investors have discovered in the past year and a half -- dangerous undertaking that requires time, training, and temperament.

It breaks my heart to see good people losing a lifetime of savings because they were lured into the stock market by the promise of easy riches and can't bring themselves to get out.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Berkshire Hathaway at press time. Mr. Tilson appreciates your feedback To read his previous columns for The Motley Fool and other writings, visit