Why Value Investing Is Broken

And will be for the foreseeable future

If you’re like me, your first exposure to the world of investing probably came through the teachings of legends like Warren Buffett and his mentor, Benjamin Graham. Their gospel was "value investing": find good, solid businesses with a competitive "moat" and steady earnings, then buy them at a discount to their intrinsic worth for an extra margin of safety. Sensible stuff. And for many, many years, it worked beautifully.

But times change. You’ve probably seen the charts – the ones that show how traditional value investing has, for the last 17 years, been consistently trounced by "growth" investing.

You’ll still see staunch supporters of value investing sharing these charts, perhaps with a knowing wink, patiently explaining that value is "due for a comeback." They sit there, stoically waiting for their investments to finally stop underperforming their benchmarks for the seventeenth straight year.

Well, I’m here to tell them they are probably going to have to keep waiting. Quite a bit longer, in fact. And the reason, in my view, is incredibly simple and ties directly into the core themes I often discuss here: currency debasement and the monetary policies that fuel it.

The Evidence: A Tale of Monetary Eras

Let's look at the relationship between growth and value through the lens of monetary conditions. Here is a chart that shows the relative performance – sometimes it's value outperforming growth, sometimes growth outperforming value. For our purposes, this chart is baselined to zero, showing how these styles have performed against each other across distinct monetary eras. Pink is growth/value (growth outperforms when this goes up), and blue is value/growth. I’ve provided the chart over three timescales to help demonstrate the point.

1. The Lead-up to the Dot-com Bubble (Late 1990s): What do we see? Growth stocks, particularly tech, went on an absolute tear. A classic speculative bubble formed, fueled by exuberance and relatively easy money for the time. Growth dramatically outperformed value.

2. Post-Dot-com Crash to Pre-GFC (Early 2000s - ~2007): The bubble popped. Monetary policy was eased to cushion the blow - Fed rate cuts – and there was some government support. But this easing was nothing by today's standards. In this environment of economic recovery and more traditional “lighter touch” monetary responses, value stocks actually had a significant period of outperformance. The economy healed more slowly, and a focus on fundamentals paid off.

3. Post-Global Financial Crisis (GFC) (2008/2009 Onwards): Then the GFC hit, and everything changed. Monetary policy didn't just ease; it went crazy. We entered the era of Zero Interest Rate Policy (ZIRP) and massive Quantitative Easing (QE) aka money printing. This unleashed a firehose of liquidity into the financial system, and thus began the period of turbocharged growth stock outperformance. You can even see on the chart how COVID-19 stimulus in 2020 sent the growth-over-value line almost vertical. Conversely, the Fed briefly attempted Quantitative Tightening (QT) in 2022, and what do you know, value stocks outperformed until that experiment was shelved.

So, that’s the evidence. It all matches the monetary script remarkably well. What’s the underlying explanation?

The Explanation: Why Debasement Kills (Traditional) Value Investing

The fundamental difference between value stocks and growth stocks lies in their expected rate of earnings growth. Value companies are typically mature businesses, growing earnings slowly and steadily (if at all). Growth companies are expected to expand their earnings at a much faster clip, often reinvesting everything back into the business to achieve that growth.

Now, let's bring in our old friend, currency debasement. As I've argued before here, the purchasing power of fiat currencies is constantly being eroded. Let's use a working assumption, based on the kind of monetary expansion we've seen (like the M2 supply charts I've shared), that the effective annual debasement or "inflation tax" on your cash is somewhere in the ballpark of, say, 8%. Add to that the typical ~2% official inflation target that central banks aim for, and you’re looking at an environment where holding cash means your purchasing power is effectively shrinking by around 10% per year.

Now, when you analyze a company for investment, you also need to factor in a "hurdle rate" – the minimum return an investor expects to compensate for the risk taken and the cost of capital. This can vary, but a 10% cost of capital might be a reasonable baseline for equities on the lower end of the “risk” spectrum for a long-term investor. I’m being kind because it is often higher.

Here’s the crucial detail: In a world where your baseline cash is "losing" 10% of its real value annually due to debasement and inflation, and you also need to achieve a, say, 10% return to make an equity investment worthwhile (to compensate for risk), then a company's nominal earnings need to grow by roughly 20% per year just for you to break even in purchasing power terms.

Think about that: a 20% nominal growth hurdle.

• If a company is not growing its earnings by at least that much in this environment, its future stream of earnings, when discounted back to today's value using this higher effective "discount rate," means its real value is deteriorating.

• A company that is achieving or exceeding this ~20% growth is actually creating real earnings growth for its shareholders.

Now, apply this to value stocks. These are companies often prized for their stability and dividends, but very rarely do they consistently grow their earnings at 20% or more year after year. In a debased currency world with a high hurdle rate, their perceived "value" based on future earnings is constantly being eroded in real terms. Their steady 5-10% nominal earnings growth lands them in the negative when the monetary environment demands much more just to stand still.

Growth stocks, on the other hand, are priced for exactly this kind of high nominal growth. Their entire narrative is built on achieving rapid expansion. While many will fail, the ones that succeed (or are perceived to be succeeding) are the ones that investors flock to in an attempt to outrun the "melting ice cube" of fiat currency.

The Future for Value: More Waiting, I'm Afraid

So, there you have it. Traditional value stocks won't start consistently outperforming growth stocks again until monetary policy fundamentally and sustainably tightens – meaning currency debasement is no longer the dominant theme, and real interest rates offer a genuine positive return on cash.

And, as we've discussed, other than for very short, sharp periods (like the 2022 QT attempt, which was quickly followed by concerns that "something would break"), a sustained return to truly tight monetary policy seems highly unlikely in a world addicted to liquidity and terrified of economic contractions. The political incentives are stacked against it.

Value investing makes perfect sense in a world of sound money and stable purchasing power. We just don't live in that world anymore, and haven't for a while. It doesn’t matter how much you yell at the clouds about why it’s so wrong. Until that changes, the growth story, fueled by the necessity to outrun a devaluing currency, will likely continue to dominate.