I’ve long been a value investor. Value investing has worked very well historically and is likely to continue to do so in the future.

At its core, value investing involves seeking out stocks trading at discounted prices. Value investors look for companies they perceive as being mispriced as opposed to merely cheap. Even Benjamin Graham—whose strategy has been described as seeking out cigar butts with one puff left—sought out mispriced stocks with his deep value approach.

While mispricing is a key part of value investing, it does not solely lie in the realm of value investing. A stock can be mispriced if it trades at a significant premium, for instance. Pay too much for a growth stock and you’re likely to be disappointed.

Some growth stocks do turn out to be big successes. Many others do not. Investors who thought Peloton Interactive Inc. (PTON) could maintain a high rate of growth have found this out the hard way. As of mid-August, the stock was trading at nearly 90% below its 52-week high. The company has been cutting staff and announced that it is scaling back its retail operations.

Peloton is a classic case of what has occurred time and time again. Investors bid up shares of a stock with an appealing story in anticipation of sustained strong growth, the company then fails to live up to the lofty expectations and its stock plunges in price. This cycle constantly repeats, burning holes through investors’ pockets in the process.

Growth investing isn’t the culprit here. Rather, it’s expectations. Investors too often misjudge the prospects for growth. They underestimate the growth prospects for value stocks and overestimate the growth prospects for story stocks—especially those with innovative or trendy products.

For growth investing to work, one must determine whether the company’s growth rate appears to be sustainable. University of Toronto professor Partha Mohanram created a metric for doing this: the G-Score. His methodology considers profitability, earnings stability and spending to determine the sustainability of a company’s growth rate.

Wayne Thorp explains what Mohanram’s G-Score measures and why in this issue. If you are a growth investor or incorporate growth as part of your strategy, you’ll want to pay attention to what underlies the G-Score.

We’ll be talking about growth more in the coming months. It’s a viable strategy when done right. Just as value works well when investors avoid companies that are cheap for a reason, growth works well when investors avoid companies whose growth is unsustainable and/or whose share price reflects unreasonable expectations.

Those of you who are value investors need not despair; we haven’t shed our value stripes. Matt Markowski shares a new value strategy based on portfolio manager Jim Cullen’s new book, “The Case for Long-Term Value Investing” (Harriman House, 2022) in this issue. The screen combines commonly used valuation metrics with an evaluation of a company’s underlying financial strength. Cullen adds what he calls a “three-point fix” to increase the odds of avoiding value traps—value stocks that stay cheap.

The New Buyback Tax

Last month, President Biden signed the Inflation Reduction Act of 2022 into law. Among the provisions included in the law is a new tax on stock buybacks.

Corporations that repurchase shares will be assessed a 1% tax on the fair market value of shares purchased during a taxable year (with some exemptions).

As of mid-August, more than 1,100 corporations in AAII’s Stock Investor Pro fundamental stock screening and research database have a buyback yield equal to or greater than 1%.

Stock buybacks affect all investors who hold shares in the repurchasing company, either directly through share ownership or indirectly through mutual funds, exchange-traded funds (ETFs), closed-end funds, ESOPs, etc. Every net reduction in the number of shares outstanding increases the proportionate ownership that every share still outstanding represents.

Whether the tax has any meaningful impact on buybacks going forward remains to be seen. My expectation is that the impact of taxing buybacks will be hard to discern once the influence that other factors (cash flows, earnings, capital expenditures, etc.) have is considered.

Wishing you prosperity and good health,