In the theoretical framework of value investment, there is a classic principle: for long-term investment, valuation change is not important. Interestingly, when many people hear this principle, they will prevaricate with the famous saying of economist Keynes: "in the long run, we are all dead." Therefore, under the banner of "I can't live that long", speculators continue to speculate and turn a blind eye to Buffett's earnest teaching that "valuation is not important in the long run".
In fact, speculators who use the phrase "we are all dead in the long run" to prevaricate that "valuation is not important in the long run" do not understand Keynes's economics or Buffett's value investment: they just confuse the two concepts.
For long-term development, Keynes can't pay attention to anything that can't be solved in the long term. In the long run, the economic development achieved by human society since the industrial revolution has little to do with economic policies, mainly the result of scientific and technological progress. Keynes's "long-term" here is a position issue of economic policy, which has nothing to do with the "long-term" in investment.
For Buffett's "valuation in the long term is not important", the long term here often refers to a cycle of 15 to 30 years. In 2021, the life expectancy of Chinese people is about 77 years old. Suppose a person graduated from college and started investing at the age of 22, with an average investment career of 55 years. How many people have no confidence in living for twenty or thirty years?
Therefore, for investment, "we are all dead in the long run" is purely an excuse of speculators. Listen to the joke. If we take it seriously, we'll lose.
how to understand
Then, how should we understand the theory of "not important in long-term valuation" of value investment? Isn't it obvious that when the valuation of PE changes from 80 times to 50 times, it will bring damage? The mystery of the matter lies in the word "long-term".
Next, let's take the 20-year long-term as an example (a "long-term" that most investors live for) to see what's going on.
Generally speaking, excellent value investors can achieve a compound annual growth rate (CAGR) of about 20%. For example, Buffett's long-term growth rate is exactly the number. Some excellent investors with more than 15 years of public performance in the Chinese market, such as Cao Mingchang and Zhu Shaoxing, have almost the same number of fundamental changes in their portfolio (pay attention to the difference between fundamentals and net worth).
So how much growth will 20% CAGR bring in 20 years? The answer is to change 1 yuan into 38 yuan. In 30 years, one yuan will be changed into 237 yuan. Now, if the valuation changes can offset the changes in fundamentals, that is, "it is important in the long-term valuation", how much should the valuation changes be?
Generally speaking, the position of value investors will not be too expensive. Let's assume that the initial PE is 20 times (this is a relatively expensive level, and the valuation center preferred by general value investors is between 10-20 times, or even lower). In the above example, in the 20-year cycle, the valuation index PE needs to drop to 0.5 times before it can completely offset the rise in the base. In the 30-year cycle, PE should be reduced to 0.1 times.
Obviously, for a portfolio with scattered positions and carefully screened, PE cannot be reduced to 0.5 times, let alone 0.1 times.
Now, do you understand why Buffett always says that valuation is not important in the long run? As long as you can achieve good enough fundamental growth and don't buy too expensive at the beginning (such as 500 times PE), the change of valuation is really not very important in the long run. Moreover, for the "15-30-year long term" of investment, the vast majority of investors "can live in the long term", rather than "we are all dead in the long term", as Keynes said.
find answers from historical data
The above is an example of model calculation. Next, let's use some practical data to see why "valuation is not important in the long run".
Take the CSI 300 total return index as an example. On May 19, 2005, the point of this index was 884 points and PE was 14.3 times. By May 19, 2022, that is, 17 years later, the point of the index was 5311 points, while PE fell to 11.9 times.
Through calculation, it can be seen that in these 17 years, the CSI 300 total income index has become 6.01 times of the original, of which the valuation has become 0.83 times of the original, and the fundamentals (here is profit, that is, E in PE) have become 7.2 times of the original. By calculating compound interest, we can know that the CAGR of market value change, valuation change and fundamental change of this index are 11.1%, - 1.1% and 12.3% respectively.
In other words, in the 17 year history of CSI 300 total return index, although the overall decline caused by valuation changes is not small (- 17%), the average annual fluctuation is only 1.1% (negative), while the average annual fluctuation caused by fundamental changes is 12.3%, which is more than ten times that of the former. It is clear at a glance which is more important or less important.
Here, I only found the relatively short data of a shares. If you go through the data of the American stock market, you will find that this is even more so. Between 1900 and 2022, the Dow Jones index is only about 30 times more expensive than PE, and the cheapest is only 5 times PE According to any 30-year calculation, even if the valuation of the Dow Jones index is 30 times and 5 times at the beginning and end respectively, the annual decline is only 5.8%, which is only 10% to 12% of the endogenous growth rate of stocks. Compared with the growth rate of about 20% that can be achieved by excellent value investors, this is a mere 5.8%. Moreover, this 5.8% is the most extreme possible result.
In other words, in the 120 year history of U.S. stocks, in any 30 years, even if the luck is particularly bad (such as 19291955 and 19691989), the value investor buys in an overvalued position and sells in an undervalued position, but as long as the value investor can make the corresponding fundamentals of his portfolio grow at a rate of 20% per year like Buffett, he can ignore the change of valuation.
Let's take another example. Wells Fargo Tianhui fund may be one of the most representative funds in the Chinese market, because its fund manager has been held by Zhu Shaoxing since November 26, 2005, and has not changed the fund manager for many years.
If we calculate the performance of Wells Fargo Tianhui in the 15.5 years from June 30, 2006 to December 31, 2021, we will find that the net value of the fund has increased by 1199.7% and the CAGR is 18.0%.
Among them, the corresponding profit part of the portfolio (the annual profit of non stock positions is uniformly calculated at 3%) increased by 1105.6% and CAGR was 17.4%. While PE only changed from 28.2x to 30.4x, bringing only 7.8% change and CAGR only 0.5%.
Of course, there is no absolute reason. If we must look at the world with a sharp eye, all logic can find faults. "Valuation is not important in the long run" does not mean that as long as we do a good job in the fundamental growth of investment, the valuation can be completely ignored. For example, if we foolishly buy a portfolio at 200 times the ultra-high PE price, and the return portfolio falls to 6 times PE, the lethality brought by valuation changes can still not be underestimated.
"It's not important in the long-term valuation" means that after we buy the stock portfolio at a reasonable price (e.g. PE below 20 times or 30 times), even if the long-term valuation changes, we can ignore the long-term valuation changes as long as we can make the fundamentals grow at a high speed (e.g. CAGR of 20% or even 30%). Moreover, long-term valuation changes are not always downward. For example, PE's long-term investment in the United States is still about twice as low as that in 1925, but the valuation of PE's stock portfolio is still about twice as low as that in 1980.
(the author is the chief investment officer of Jiuyuan Qingquan Technology)
