The Value Factor’s Pain: Are Intangibles to Blame?
What is driving the value factor?
December 2020. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- The rise of intangibles has been increasingly used as an argument for the poor performance of the value factor
- However, this idea is not supported by data
- The type of market environment is marginally more useful for explaining the value factor performance
INTRODUCTION
Great storytelling may be the most powerful human skill. Empires have been built by lone individuals whose enthralling narratives convinced their compatriots to join the cause. In the right hands, these narratives can rally hearts and minds to achieve a common purpose that serves the greater good, as when John F. Kennedy challenged his fellow Americans to go to the moon.
In the wrong hands, however, great storytelling can lead to untold destruction. And that’s especially true in finance.
Investors waste billions each year in the pursuit of false and misleading narratives. Maybe a charismatic founder — WeWork’s Adam Neumann, for example — convinces them that a traditional real estate company should be valued at technology stock multiples. Or an asset manager persuades them to buy thematic securities when they’re trading at their peaks, say cryptocurrencies in 2017 or cannabis stocks in late 2018 and early 2019. Or in the midst of a real estate bubble, an eminent economist points out that US housing prices have never declined on a national level, convincing many that they can’t fall. The appeal to authority, or the ad verecundiam fallacy, thus gives investors false comfort in flawed investment propositions.
Take the recent performance of the value factor, which is defined as buying companies with low price-to-book multiples and shorting those with high price-to-book multiples. The strategy has disappointed for years. “It has become a bad environment for value and this time is different,” some say. Why? Because intangibles have increased as a percentage of the valuations of fast-growing tech companies and thus rendered value obsolete.
We are suckers for stories and this one has a simple and intuitive appeal that is hard to resist. Valuing tech firms on traditional price-to-book multiples does feel like an outdated approach. We’ve all seen how tech companies have transformed modern life, from how we meet with colleagues (virtually via Zoom) to h
