The quality versus value debate

The Noise

An impeachment enquiry has formally begun in the US, with President Trump accused of seeking foreign help to smear the reputation of Democratic candidate Joe Biden. The controversy revolves around a phone call whereby Trump is heard trying to convince Ukrainian president Volodymyr Zelensky to investigate claims of corruption involving Joe Biden’s son.

British politics was of course no less dramatic this week, as the Supreme Court ruled that the Boris Johnson’s proroguing of Parliament was unlawful, leading to the reconvening of Parliament and a cacophony of abuse towards the Prime Minister on Wednesday’s sitting.

The world’s oldest travel company, Thomas Cook was forced into compulsory liquidation this week, leaving employees, holidaymakers, shareholders and hotel staff in various states of dismay. The share price had already collapsed earlier this year, closing at 3.45p on Friday from a high of 136p in May last year. Several high profile fund managers were stung by the fall in value, but most had managed to exit positions before liquidation.

The Numbers

The Nuance

One of the oldest debates in the investing world is that of “quality” versus “value” investing. The former tends to involve investing in companies with more predictable cash flows and revenue streams while the latter involves looking for stocks that are cheap, but which you expect to bounce back. While we are advocates of balance in portfolio construction, ultimately we look to the compounding power of quality businesses to power our portfolios over the long term.

Cheap stocks can bounce back to tremendous highs, but, as we have seen in the case of Thomas Cook this week, they can also have disastrous trajectories. The company was highly leveraged, had paper thin margins and was highly susceptible to cyclical swings in demand. Its low price attracted a good deal of value investors, but it ended up being a “value trap”, and stands as testament to the maxim “just because it’s cheap, doesn’t’ mean it can’t get cheaper”, or in this case, go to zero. All equities carry risk, our job is to work out which risks are worth taking and how they can be counterbalanced by other holdings in the portfolio. The difficulty with value stocks is that their trajectories are harder to predict, they tend to increase portfolio volatility, and they are highly sensitive to the macroeconomic environment.

Quote of the week

Order! Order! Order! Order! Order! Order! Order! Order! Order! Order! Order! Order!”

No that isn’t a typo, the Speaker of the House did indeed shout that word in his inimitable tones, no less than 12 times in a row in order to regain control of an impassioned gathering of Parliament on Wednesday. Mud was slung from both sides of the benches, mostly directed at the Prime Minister, who is accused of using inflammatory and improper language in his public discourse around the Brexit debate. Johnson, never a stranger to obscure classical references or a Dickensian turn of phrase, responded to the accusations by saying “I have never heard such humbug in all my life.”

Source: wsj.com