How value investing is making a comeback, according to Chris Davis

Chris Davis, a seasoned value investor and chairman of Davis Advisors, has spent years navigating the ebbs and flows of the market. While value investing has long been a cornerstone of his philosophy, the recent market landscape has presented unique challenges. With growth stocks dominating headlines and valuations soaring, value investing has faced an uphill battle. In a recent interview with Barron's, Davis shed light on why value stocks have struggled in the post-pandemic era and why he believes their time is coming again. We lay out key insights from his chat:

Why value investing has struggled

For years, the debate between value and growth investing has raged on. But the post-pandemic era, fueled by easy money policies, has tilted the scales heavily in favor of growth stocks. According to Davis, the root of value's underperformance after the pandemic boils down to two unprecedented market shifts.

"For the first time in history, money was essentially free," Davis explains. "Zero or near-zero interest rates disrupted the traditional valuation framework, making cash flow 10 years in the future worth the same as cash flow today."

This ultra-low interest rate environment, which lasted for nearly 15 years, reshaped investor behaviour. With money so cheap, future cash flows were discounted at negligible rates, leading to an era of hyper-valuation for growth stocks. Companies with dominant market positions—think Amazon and Google—were seen as invincible, their networks considered so vast and entrenched that their future growth seemed all but guaranteed, Davis remarks.

"Investors became infatuated with the idea that these businesses had built insurmountable ecosystems". The value of these networks, which grows exponentially with the number of users, made them appear invincible. But this perception wasn't always rooted in reality.

However, the game changed in March 2022, when interest rates started climbing, marking a turning point that forced investors to rethink their assumptions. In a rising-rate environment, distant cash flows are no longer as attractive, leading to a recalibration in how companies are valued, he notes.

"The market now demands realistic expectations. We're back to a world where discipline, prudence, and rational pricing matter. This is good news for disciplined value investors."

Inside his investment strategy

When it comes to identifying opportunities, Davis emphasises the importance of thinking like a business owner, not a stock trader. "We don't just buy stocks; we buy businesses". This means evaluating every aspect of a company—from its liabilities and underappreciated assets to its long-term competitive advantages.

His investment philosophy centers on finding "durable, resilient businesses with sustainable competitive advantages." He values long-term endurance over short-term earnings volatility. "Durability trumps lumpiness", he says, highlighting banks as "undervalued durable franchises."

Banks, a significant part of Davis Advisors' portfolio, are emblematic of this philosophy. "Capital One is our largest holding," he reveals, describing it as a "growth stock in disguise." Despite lingering fears from the 2008 financial crisis, he believes banks today are far more resilient. "They have twice the capital they did before the crisis and have weathered Covid and rising interest rates with remarkable stability."

Another example of his contrarian thinking is Meta Platforms. "Two years ago, Meta's market cap was smaller than Home Depot's," Davis recalls. While many investors focused on competition from TikTok and questioned Meta's AI and AR investments, Davis saw an undervalued opportunity in a company with over 2.5 billion engaged users.

On value investing's comeback

Reflecting on the broader market landscape, Davis sees a shift from an era of "free money" to one where money has a cost. "Investors got used to thinking that low rates and unlimited government spending could last forever. But reality always catches up."

This new environment is paving the way for price discovery. Davis believes the key to success now lies in disciplined stock picking—finding businesses that are not only resilient but also undervalued. Another critical component in the process is recognising that "growth is a component of value" rather than being different from it, as conventionally believed. "A company that grows profitably is more valuable than one that doesn't grow", he notes.

Also read: Mastering market cycles with Howard Marks

This article was originally published on January 27, 2025.