The failure of many so-called “growth stocks” to surge ahead in today’s stock market has puzzled value investors. After all, the traditional use of measures, such as price to earnings ratio and price to asset ratio, has served many investors well over the years. But for many investments in the stock market, it is not working today! Growth stocks keep forging ahead while stocks with low price to asset ratios are lagging. The questions we want to bring up are which growth stocks are really value investments in disguise? And, which value stocks are really not so valuable?
Successful Investing by Seeing the Future
We commonly use intrinsic stock value as a guide to successful investing. This approach assumes that you can successfully predict the income stream that an investment will generate in the coming years. Then, you look at the current stock price as well as the financial condition of the company. Here is where the Generally Accepted Accounting Practice that is used to do the books may not serve a modern investor very well. There are factors that may overstate the value of a so-called “value stock” and understate the value of a so-called “growth stock”. The Wall Street Journal looks at the traditional way of measuring value stocks and offers some advice to investors.
Is “value” dead? Or have we just been measuring it in the wrong way?
It’s an urgent question, because value stocks-when defined according to the traditional criterion, low price-to-book-value ratios-have lagged behind growth stocks for at least a decade now. And though value stocks in the past have come roaring back after going through similarly long periods of lagging, some researchers are questioning whether they will do so again.
The point that the WSJ makes hinges of how “intangible assets” are treated in the world of accounting. What is important when predicting the future of a stock is being badly represented in financial statements.
That’s because a growing percentage of companies’ market value now comes from intangible assets-things like patents, trademarks and research-and-development expenditures-that are either ignored in the book-value calculation or reflected inconsistently. Therefore, the researchers say, the price-to-book ratio has lost its relevance.
If they are right, we can’t expect stocks with the lowest such ratios to reassert their historical dominance over stocks with the highest ratios.
Stocks that keep going up are those that keep increasing their earnings. The value of many of these companies lies in their names, trademarks, and patents. The money that they pour into R&D comes back as new products, more efficient ways to produce their products, dominance of their market niche, and creation of totally new market niches. The market keeps rewarding the companies that are following this path because their earnings are steadily increasing. Which growth stocks are really value investments? The first trillion dollar company, Apple, fits the mold of a company that is steadily growing based on continual product improvement, strong R&D, and lots of patents. Johnson & Johnson and Microsoft, the only two companies with AAA corporate bonds as mentioned in our article about how to invest without losing money, also fit the mold. Until they change the way that “intangibles” are reported by the accountants, earnings may be the best guide to picking “value stocks.”