If an investor were forced to remember one principle, it would be Howard Marks’ iconic dictum: not all assets are excellent at all prices. Over the past 10 years, the market has consistently favoured growth stocks over value stocks. With low-interest rates and easy monetary policy, the ample money supply ensured more money was chasing a handful of stocks in the market.

These ‘growth’ companies have consistently been touted as high-performers by those in the industry during this period in India. Some candidates subject to adulation include Asian Paints, Nestle, HUL and Gillette. During this period, undervalued companies classified via price-to-earnings ratio (P/E ratio) were seen as under-performers and laggards.

Companies such as ITC, which had a considerably lower P/E ratio than peers and a higher dividend yield, remained ostracised by the general market for over a few years. Before examining the results of the debate, let us delve into the rationale that proponents of the ‘growth will pay for valuations’ espouse.

Dual-pronged

The crux of the growth over value argument is dual-pronged: i) These companies grow at a consistently high rate over a while, and ii) The high rate of growth, when discounted to the present time, ends up more than compensating for the large P/E ratio. When looking at the growth rate of a company such as Asian Paints, which has a compounded profit growth rate of 15 per cent over the past three years, the first thought that comes to mind is it does not seem to truly reflect the enormous rates of growth we associate growth companies with. Asian Paints in 2021 commanded a huge P/E ratio of 119.9 on January 8, 2021. An interesting picture emerges when looking at the growth of its stock price over three years. The price grew by a measly 5 per cent a year compared with the growth rate of 15 per cent. The P/E ratio of Asian Paints fell accordingly to 62.

Poor performance

Those who ended up investing in Asian Paints in 2021, continuing to believe the asset was fairly priced and paid for its sky-high valuation, were subjected to poor performance despite consistent growth. Similarly, over the past three years, HUL and Gillette India posted compounded profit growth rates of 14% and 16%, respectively. However, their stock price’s compounded annual growth rates stood at 3% and 5%. The P/E ratios shrank considerably.

On the other hand, ITC has been continuously undervalued or fairly valued, with a P/E ratio of 17-19 during 2021. It had fallen out of favour during Covid-19 and remained so the year after. It delivered a compounded profit growth rate of 7 per cent over the past three years, while its stock price’s compounded annual growth stood at 32 per cent.

Another example of an undervalued firm that saw a reversal was Exide, which posted a compounded profit growth rate of 1 per cent over the past three years, but a stock-price growth of 18 per cent over the same period.

Unsurprisingly, it was out of favour during and shortly after the Covid-19 period, leading to outsized returns when there was a reversion to the mean. Supporters of growth-based investing dispute the idea of reversion to the mean, stating it may take an extended period for it to occur. Nonetheless, we see that over the past three years, there have been considerable gains to be made through a purely P/E ratio-based investing approach. In his memo, Mr. Marks famously stated, “We believe the easiest way to make unusually high risk-adjusted returns is to buy from depressed sellers and sell to euphoric buyers… thus to buy when assets are under-priced and sell when they’re overpriced. The opposite is a nightmare.”

Evidently, in an ocean of growth-based investors banking on ultra-low interest rates and abundant capital to maintain buoyant valuations, it pays to be a value investor following the valuation-based method of investing.

In conclusion, the last decade’s market trends underscore the wisdom of Mr. Marks’ principle: the quality of an asset is not immutable but highly contingent on its price. Despite the prevailing preference for growth stocks fuelled by low-interest rates and generous money supply, the performance of companies like Asian Paints, HUL, and Gillette reveals that high growth rates do not always justify steep valuations.

ITC and Exide illustrate a value investing approach, characterised by more modest P/E ratios and solid dividends, can yield significant returns, challenging the growth-at-any-cost mindset.

Anand Srinivasan is a consultant and Sashwath Swaminathan is a research assistant at Aionion Investment Services

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