The EconomistJune 27th 2020 Finance & economics 612
Buttonwood A long shadow
T
here is alovely quotation at the start
of “Security Analysis”, a canonical
text by Benjamin Graham and David
Dodd published in 1934. “Many shall be
restored that now are fallen and many
shall fall that are now in honour.” It is by
Horace, a Roman poet who knew all
about reversals of fortune, having lived
through Rome’s bloody transition from
republic to empire. Two millennia later,
amid the ruins of the dotcom mania,
Warren Buffett was moved to recall Hor-
ace’s words. “My appreciation for what
they say about business and investments
continues to grow,” he wrote.
It is now 20 years since the nasdaq, a
tech-heavy index of shares, reached a
peak after a frenzied rise during the late
1990s. The apex, on March 10th 2000,
marked the end of the internet bubble.
The bust that followed was a triumphant
vindication of the sober valuation meth-
ods pioneered by Graham and Dodd and
popularised by Mr Buffett. True value is a
low price relative to some financial
measure of intrinsic worth—recent
profits, say, or the book value of assets.
Dotcom-era analysts, if they bothered at
all, used flakier metrics: “eyeballs”, “en-
gagement” or simply “the opportunity”.
Perhaps you can have too much sobri-
ety. For the past decade buying “value”
stocks has been an unrewarding strategy.
America’s stockmarket is dominated by a
handful of technology companies,
whose stocks trade on steep multiples of
earnings and book value. The current
recession has not changed matters. The
fallen have not been restored. If any-
thing, those in honour have more of it.
Value investors, meanwhile, are un-
moved. This begs a heretical thought. If
the dotcom boom and bust had not hap-
pened, would value investing have quite
the same moral authority today?In posing such a question, you run into
an immediate problem. Value investing is
an austere creed. It is as much about moral
fibre as business analysis. Value investors
hope to be rewarded for enduring the pain
of waiting for their strategy to come good.
Most investors don’t like to be wrong for so
long, to hold the unfashionable stocks and
to spurn the faddish ones. But value in-
vesting is a faith that is sustained by the
scepticism of non-believers. Indeed their
scorn is in large part the point of it. For its
adherents, vindication will surely come. It
has before, even when all seemed lost.
That makes rebutting its tenets hard.
The legacy of the dotcom bust makes it
all the more difficult. So as a thought
experiment let’s imagine, for a moment,
that the late 1990s bubble never happened.
Value investing would have lacked its most
spectacular vindication. Its hold on the
investment world would be less secure.
The use of forward-looking scenarios to
judge the long-term prospects, and thus
the worth, of a fast-growing company
could not be so easily decried as foolish.
The business of stock-picking would bemuch more about engaging with, and
understanding, the peculiarities of
companies rather than an arms-length
selection based on financial characteris-
tics. And without the frauds and scandals
of the late 1990s, the public markets
might have remained a welcoming place
for small, early-stage firms. More start-
ups might in turn have tailored them-
selves for an iporather than for a sale to
an incumbent technology giant.
The value creed says rapid growth
must eventually peter out. Instead the
big business successes of the past de-
cade—Google, Amazon and Facebook in
America; Alibaba and Tencent in China—
have grown to a size that was not widely
predicted. Companies of this kind are
characterised by network effects. The
more people use them, the more useful
they are to other customers. They enjoy
increasing returns to scale. The bigger
they get, the cheaper it is to serve another
customer. Dotcom-era gurus banged on
about the power of network effects and
scale economies. There is more to build-
ing an enduring company, though. A
business also needs something unique, a
distinctive culture or a superior tech-
nology, that cannot be replicated by
others. Picking winners is not easy; nor
is paying a price for them commensurate
with their chances of success. But
screening for stocks with a low price-to-
fundamentals is more likely to select
businesses whose best times are behind
them than it is to identify future success.
In the late 1990s ideas about funda-
mental value went by the wayside. A
bubble blew up. It then burst dramatical-
ly. The bust was a painful lesson for
investors. But perhaps some lessons
were learnt a little too well. “When fools
shun one set of faults”, wrote Horace,
“they run into the opposite one.”Investing would be very different if the dotcom boom and bust had never happenedEconomic Research since 1980 mentioned
“race”, “racism”, “racial”, “black” or “Afri-
can-American” in the title or abstract. But
theaea’s statement tacitly acknowledges a
shortcoming: it pointed people not to re-
search in its own elite journals, but to the
Review of Black Political Economy, which is
neither well-cited nor widely read.
More mainstream research has come
under attack for treating race too narrowly,
in a way that leaves important context un-
explored. When studying discrimination,
for example, economists often ask only
whether it is motivated by animus (“taste-based”), or by a lack of information that
forces people to rely on stereotypes (“sta-
tistical discrimination”), without asking
why such tastes and stereotypes exist in
the first place. Some evidence suggests that
economists think too narrowly within that
framework. A study by J. Aislinn Bohren of
the University of Pennsylvania, Kareem
Haggag and Alex Imas of Carnegie Mellon
University and Devin Pope of the Universi-
ty of Chicago found that, of 105 papers in
top journals testing for discrimination be-
tween 1990 and 2018, only 11% discussed the
possibility that statistical discriminationmight be based on odious beliefs.
A solution would be to acknowledge
rather than sideline existing research that
delves into the cultural context. Encourag-
ing scholars working in the area would
help. Dania Francis of the University of
Massachusetts Boston was told that as a
black person doing research on race (“me-
search”) she would be taken less seriously.
For Lisa Cook, a member of the aea’s exec-
utive committee, the very fact that it issued
a statement is progress. But avoiding an-
other conversation in 50 years’ time will re-
quire more than that. 7