09 Dec

EPIQ Blog: When is Less, More?

The investment industry does a tremendous job of categorizing the discipline of investing into numerous strategies. Entities involved in managing money extoll the benefits of their approach as to why their approach adds value. It does not matter as to whether it is stocks, bonds, real estate or commodities, or in public or private markets, the debate rages as to how best to invest.

One aspect that comes up for most who invest in equities, is whether to pay up for 'growth' or seek out 'value'. We find this debate and how it is framed, to be foolish. Humans, proclaiming to be rational decision makers (different discussion all together) should always pursue the choice with the highest perceived value. How we define value makes for interesting debate. Anyone who has made an investment decision surely perceives value in whatever they ultimately choose. The market determines the price of financial assets; it is up to the investor to determine whether value exists at that price.

As we reflect on 2015, it has been a lack-luster year for most US-based investors. Except for those with significant exposure to FANG (Facebook, Amazon, Netflix and Google), returns have likely been negative for a broadly-diversified portfolio. This very narrow breadth of internet-related companies, reminds us of the late 1990's when the four horsemen, Microsoft, Intel, Cisco and Oracle drove averages significantly higher during the era of the 'new economy'.

In examining one of the best performing companies over the last couple years, Amazon has and continues to transform consumer behavior and the retail experience. It is safe to say that Amazon's disruptive deployment of technology is highly valued by the market. However, we question its relative financial value to current and prospective investors moving forward.

As of this writing, Amazon carries a market value of approximately $316 billion based on a share price of $670. For that same amount of money, one could own a share of Southwest Airlines, Adidas, Marriott International, CBS, Digital Reality, Costco, Rackspace Hosting, UPS and Norfolk Southern. The combined market value of those nine companies is just under $300 billion! Amazon sales over the past year were $100 billion and has terrific growth prospects. The combined sales of the other nine were $250 billion. Amazon has virtually no reportable earnings (by choice) and produced a mere $5 billion in operating cash flow. This compares to approximately $14 billion in earnings and $27 billion in operating-cash flow with the group of nine listed above. Amazon has never paid a dividend or returned any capital to its shareholders. Over the last year, a share in the nine companies distributed almost $17 which does not include cash that was used to buy back shares.

Most value-oriented investors would likely prefer the basket of nine to Amazon as the traditional measures to gauge business valuations would surely point to a better risk/return profile and margin of safety. Unfortunately for them, over the past year, Amazon has returned over 100% when the basket returned 3% including a little over 2% in dividends. For reference, the S&P 500 has returned 1%.

Is this relationship rational? Trees do not grow to the sky, or in this case, rivers do not flow forever. Eventually they empty into the sea or, on rare occasion, head over a cliff. We do not wish impairment upon the shareholders of Amazon or any other company, but should their competitive advantage dwindle with the introduction of an internet sales tax, for example, we suspect that their lofty valuation would be in jeopardy.

Evaluating this analysis from a broader view, 'value' defined as stocks trading at cheaper valuations, has outperformed 'growth' since the 1920s by a significant margin. However, like all generalizations, there are periods of exception. Since 2007, 'growth' has outperformed 'value' by nearly 3% annually. As the nature of the global economy has developed and the rate of change increased, investors have also evolved as to what they value most. We don't believe that this change is permanent and at some point, there should be a reversion back to historic norms. Click here for a timely article that addresses this topic: CFA - O' Value Where Art Thou. 


PRESS RELEASE: Five Star Professional is pleased to announce Bruce Langer, CFA, and Dan Aronson, CFA, of EPIQ Partners, LLC have been chosen as two Twin Cities Five Star Wealth Managers for 2016. Click here to see the full release: Five Star Professional. 


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