Value Investing Explained
A real-world example of value vs. growth
The best way to explain value investing is with real securities. Theory is nice, but how does value work in practice? In this post we will show two companies, one a slow-growing “value” company, and the other a fast-growing technology stock. Why the value stock outperformed is both surprising and fundamental to the strategy. Read on to have value investing explained with real-world examples and what fundamentals make a great value stock investment.
Two Stocks – One Value One Growth
Meet company “A” and company “B.” Company A is an exciting growth company, with its initial public offering in June 2020. The stock started trading at $70, and the prospectus showed revenue growth rates of well over 100%. As is typical of companies focused on growth, Company A spends more than its gross profit on expenses like sales and marketing to aggressively capture its market opportunity. This spending leaves no room for dividends or stock repurchases. Company A traded around 30x trailing revenue in 2020, a very high valuation even for a fast-growing corporation.
Company B is a slow-growing value stock. During the same time period of Company A’s IPO, Company B had been suffering flat growth for years. Though a steady producer of profits, investors feared declines in Company B’s business in June of 2020, and sold its stock price down to about 7x previous years’ earnings and a 6% dividend yield. The price in June 2020 was $15. Additionally, management elected to use all remaining free cash flow after the dividend to repurchase shares. The setup of low valuation, high dividend, and material share repurchases enabled Company B to outperform Company A in the next two years.
Value Investing Explained – Results
What was the end result? With rising interest rates and inflation, investors lost patience for growth companies unable to reward shareholders with dividends and repurchases. Company A current trades around $30, down more than 50% from its IPO price in June 2020. What about Company B? It is a shining example of how value investing works. Company B appreciated over 200% from $15 to $48 at the time of this writing, not counting the 6% dividend an investor would have received in each year.
In this example, a low valuation and shareholder friendly management gave Company B the tools it needed to increase its stock price. From the starting line in June 2020, Company B investors received a 6% dividend while Company A investors received nothing. Add in Company B’s repurchase of stock, which in 2020 was around 10% shares outstanding and 2021 around 15%, and you have a recipe for gains. This value investing example shows how even with very little top-line growth, shareholder friendly companies can outperform high growth businesses. Curious as to what our two companies are? See the chart below. Also read our investment case for H&R Block in Frank Value Fund Q4 2020 Letter to Shareholders.
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end by calling the Fund at 1-888-217-5426 or visiting our website at www.frankfunds.com. Returns include reinvestment of any dividends and capital gain distributions.
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The information in this portfolio manager letter represents the opinions of the individual portfolio managers and is not intended to be a forecast of future events, a guarantee of future results or investment advice. Also, please note that any discussion of the Fund’s holdings, the Fund’s performance, and the portfolio managers’ views are as of August 17, 2022 and are subject to change without notice.