I am not talking about a crisis or a bear market — though the market’s December drop does play a role in it.
The shift I’m talking about will bankrupt many investors who’ve made gobs of money during this historic bull market over the past 10 years … and make millionaires out of a totally different type of investor.
Whether you are one of those millionaires will depend entirely on your understanding of history. Anyone with a passing knowledge of stock market history should already know all about the massive shift I’m about to describe …
I’m talking about a shift in the balance of power between two huge investment forces …
This idea first appeared in a little-known book published in 1924. That’s the year an investment adviser named Edgar Lawrence Smith published a terse little volume called “Common Stocks as Long Term Investments.” The book laid out the research Smith had done on the historical performance of stocks and bonds.
Originally, Smith thought he was sitting down to write a pamphlet on the superiority of bonds as long-term investments. He examined decades of stock and bond price data, from 1837 through 1922.
To his great surprise, Smith found that stocks had been the better long-term investment …
Today, this seems like a no-brainer. But back then, it was a tectonic shift in the widespread belief of the day. As Smith wrote …
Common stocks are, in general, regarded as a medium for Speculation — not for Long Term Investment. Bonds, on the other hand, are generally held to be the best medium for Long Term Investment — free from the hazards of Speculation.
Smith compared several baskets of more or less randomly chosen stocks versus high-grade bonds. The result was always the same: Stocks outperformed bonds.
He realized that earnings reinvested in the business — rather than being paid out in dividends — caused stock prices to go up over the long term.
Over the long term, Smith concluded, investors could count on a well-diversified portfolio of stocks to generate substantial capital gains and dividend income superior to the highest-grade bonds. He wrote …
In the selection of securities for investment, we must consider more than the expected income yield upon the amount invested, and may quite properly weigh the probability of principal enhancement over a term of years without departing from the most conservative viewpoint.
The idea of growth in principal as conservative was radical. But by 1929, Smith’s book was a bestseller, and “growth investing” was hot, with shoe-shiners and hairdressers trading stock tips and playing the stock market on margin, despite Smith warning investors to avoid “the extreme misfortune” of investing at a market peak.
When the crash of 1929 came, it wiped out thousands of investors, leading the world into the Great Depression …
At the depths of the Depression, another analyst published a radical new view of investing that would change the world forever.
Investor and teacher Benjamin Graham, aided by his partner David Dodd, published “Security Analysis”, a 725-page, all-encompassing guide to analyzing bonds, preferred stocks, and common stocks the likes of which had never been published before (or since).
Graham called Smith’s book, which totals 140 pages, a “small and rather sketchy volume.” He made the case that Smith’s book caused investors to focus too much on extrapolating the trend of earnings growth into the future.
Graham said the traditional approach to investing, which focused on “past records and tangible facts, became outworn and was discarded” in the 1920s as Smith’s ideas gained popularity. “The past was important only in so far as it showed the direction in which the future could expected to move,” Graham said. That’s the classic mistake of all growth investing: the belief that trees will grow to the sky.
In Graham’s view, “The Common stocks-as-long-term-investments Doctrine,” a clear reference to Smith, was based on three ideas …
1. “The value of a common stock depends on what it can earn in the future.”
2. “Good common stocks will prove sound and profitable investment.”
3. “Good common stocks are those which have shown a rising trend of earnings.”
Graham and Dodd immediately pointed out the two weaknesses in these assumptions. They “abolished the fundamental distinction between investment and speculation [and] they ignored the price of a stock in determining whether it was a desirable purchase.”
Graham was showing the world the flaws of growth investing, and advocated replacing it with sensible principles which today are known as “value investing.”
Later, I’ll show you that over the long term, value trumps growth. But there’s a subtler point here …
Longtime readers of my work know the market tends to shift the balance of power back and forth between growth and value every several years. Growth has outperformed since 2009, and it looks like value is getting ready to take the lead for the next five to 10 years.
This is perhaps the single most exciting moment of my entire career as a value investor and equity analyst. Value has under-performed growth for 10 years, and we are likely within several months of a major blow-off top of the longest bull run in stock market history.
There’s something else you ought to know about value investing …
You need to start doing it BEFORE the bull market ends.
Investing legend Warren Buffett gave a speech in 1984 called, “The Superinvestors of Graham-and-Doddsville.” It chronicles the record of investors who worked for and learned from Graham.
One was Walter Schloss, who never went to college, but took a night course from Graham. Schloss made roughly 21% a year over a period of more than 28 years, when the S&P 500 gained just 8.4% per year. During that time, the S&P 500’s worst performance was in 1974, when it fell 26.6%. It was a brutal year for the market, but Schloss was down a mere 6.2% that year.
Buffett also mentioned value-investing firm Tweedy, Browne. It made 20% a year over a period of nearly 16 years, when the S&P 500 returned just 7% a year. Tweedy, Browne gained 1.5% in 1974 (the year the broad market fell 26.6%).
Buffett related the records of five more “Graham-and-Doddsville” value investors. Not all of them outperformed in 1974, but they all trounced the overall market by a wide margin over periods of more than a decade.
A more recent study by Bank of America Merrill Lynch looked at the 90 years between 1926 to 2016 and used another value/growth data set by economists Eugene Fama and Kenneth French. The cheapest stocks made 17% per year, while the most expensive growth stocks made just 12.8% per year — a huge difference when compounded over the long term.
The data on growth versus value during bad times is mixed …
As The Wall Street Journal reported last July …
In bear markets before 1970, for example, the 50% of stocks nearest the growth end of the spectrum outperformed the 50% at the value end by an annualized average of 3.8 percentage points. In the bear markets of the subsequent four decades, however, it was just the opposite, with value beating growth by an annualized average of 10.7 percentage points. The current decade appears to be reverting to the pre-1970 pattern, with value lagging behind growth in both the 2011 and 2015-16 bear markets.
Again … I believe we’re on the cusp of a huge shift back to the outperformance of value during the next bear market. It’s worth pointing out that value beat growth by an astounding 32% annualized from the dot-com top in early 2000 to the bottom in October 2002. The current mania smells a lot like that period to me, even if it is just one data point.
If you want to avoid the carnage of the next few years, become a value investor right now.
If you want to maximize the performance of your capital over your lifetime, become a value investor right now.
If you want to take less risk, sleep better, and make more money in stocks, become a value investor right now.
Value investing is hands down the best way to make a fortune in the stock market …
It’s how I recommend investing the overwhelming majority of your portfolio.
History suggests that value investing is about to shine brighter than it has in nearly two decades. It has never under-performed growth investing for this long … So, it’s like a giant rubber band that has been stretched further than ever before.
Given the recent struggles of market darlings Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL), and other growth stocks lately, the rubber band looks like it has been released and is starting to snap back in a big way.
The market is telling you that a much bigger shift between growth and value is likely in the next few years …
Value investing naturally prepares you for bad times by discouraging you from buying what’s popular and expensive. It encourages patience and discipline — exactly what’s been lacking in the market for most of the past decade. You can’t predict bear markets, but you can prepare for them by being a value investor.
My chief research officer Mike Barrett and I have that kind of discipline. In our Extreme Value advisory, we recommended just two stocks in 2015 as we warned investors most stocks were just too risky. It turned into the worst year for stocks since 2008.
We found alcohol titan Constellation Brands (NYSE:STZ) in 2011 and rode it to a 631% gain — one of the highest-returning recommendations in Stansberry Research history, all from a stodgy, ignored booze company.
Recently, we’ve found great value in a handful of different industries …
In the past several months, we’ve recommended a pipeline company, an old chemical company, and two shipping companies — classic Graham-and-Dodd value stocks.
We waited more than a year to recommend one stock until it finally got cheap enough for our liking. We recommended shares last August and soared up 32%. We think it’ll double over the next few years.
And with gold cheap relative to stocks, we continue to recommend investing in the two best businesses in the global mining space, bar none. One owns royalties on a diversified group of mines.
The other owns a royalty-like income stream on millions of ounces of gold, silver, platinum, and palladium above the ground.
You won’t find two better business models in the gold mining space. And you won’t find better downside protection, bigger (realistic) upside, or better management teams. Both are trading at cheap cyclical lows and ready to roar over the next five to 10 years. I believe the shift to value will send them up 10 to 20 times current levels as they continue to pay rising dividend streams.
I can’t predict the future and I have yet to meet anyone who could. But I’ve closely studied the past and the present, and as I’ve said before, I know two things for sure: where we stand and what to do about it.
Extreme Value isn’t for everyone. But if you have the discipline and desire to exploit a huge, long-term advantage in the stock market over the next five to 10 years, it might be for you.