Are Growth and Value Dead?

Lawrence S. Speidell, Partner Nicholas Applegate

Someone once said: “Nowhere is value so perfectly calibrated with price as in cigars”. Unfortunately, stocks are not cigars; and as a result, investors have searched for years to identify the perfect clue to value, and thus to future performance. The search for value in stocks has led to elaborate frameworks for the valuation of investments as well as elaborate frameworks for the evaluation of the styles of investment managers themselves. In light of recent market volatility, these frameworks may deserve some re-examination. 1999 was the sixth consecutive year in which the S&P BARRA Growth Index outperformed the Value Index. Some investors have questioned whether Value will ever again be a successful investment approach. Some of them believe this is a “New Era” in which technology stocks are revolutionizing the way business is done: “New Economy” stocks will survive while “Old Economy” stocks (mostly Value stocks) will become extinct. Other investors say that growth stocks are mostly driven by a technology stock bubble which is bursting and will lead to a return of classic fundamental analysis, favoring value stocks. Then there are observers who believe that the debate is defined too narrowly. They say that “Traditional” or “Deep” Value is too rigid a definition, whereas the concept of “Flexible” Value will better cope with the opportunities changing the world. Finally, there are observers who question the whole Value/Growth framework, which has been used widely since Callan is believed to have established it in the mid-1970s. Some of these critics say that Growth is not the opposite of Value; it is the creator of Value – without understanding potential for growth, one cannot correctly identify value…. History Value investing (in fact all professional investing) traces its roots to Graham and Dodd’s classic book Security Analysis, first published in 1934. At the depths of the Depression, they stressed the importance of fundamental analysis and the use of financial statement data to compare stocks. Over the last 30 years, practitioners have applied the term “Graham and Dodd” research to describe value investing as opposed to growth investing, but the authors did not make that distinction. Their discussion of sound investment value included assessing the “favorable possibilities for future growth”. With the rise of institutional investing in the 1960’s and 1970’s, however, the practice of dividing security analysis was divided into two basic camps, value and growth investing. Consultants, especially at Callan Associates, adopted these styles as two opposite poles and built them into today’s framework of portfolio diversification. Academic researchers have explored the characteristics of the value and growth styles, and they have often concluded that value stocks can be defined as stocks with a low price/book ratio, while growth stocks tend to have a high ratio. They have further suggested that value stocks (so defined) tend to outperform the so-called growth or “glamour” stocks. Numerous papers discuss this topic, including Fama and French [1993]. Dave Umstead and Lyle Davis [1995], Josef Lakonishok [1994], Barton Biggs [1995] and Bill Sharp [1993]. Ibbotson Associates published a chapter in their Yearbook 2000, which concluded that from 1927 to 1999, value stocks had returned 13.4% per year whereas growth stocks had returned only 10.2%. By the mid-1990’s many academic papers stated flatly that “Value outperforms Growth”, and some institutional investors responded by terminating their growth managers or at least tilting their asset allocation in favor of value. Unfortunately, many of these moves came at precisely the wrong time, as shown in the chart below.

Figure 1

S&P/Barra Value Index vs. Growth Index

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As shown in Figure 1, from 1975 to 1993, Value outperformed in 11 out of 19 years. From 1993 on, however, value has not outperformed at all. At the end of 1999, the firm of AXA Rosenberg found that their measure of growth stocks outperformed value stocks by 125% over the prior 18 months, representing a 6.8 standard deviation event, which “should occur only once every 285 billion years”. Benchmarks Part of the issue of Growth versus Value lies in the validity of the benchmarks we are using to describe these disciplines. Most index providers use similar methodologies, but there are differences as shown in Table 1 below. While BARRA, Russell, Wilshire and MSCI rely heavily on Price/Book as a discriminator, Russell also uses Estimated Growth, Wilshire and Prudential use Earnings to Price and Salomon used three growth and four value measures. Table 1 Value/Growth Index Methodology: Book to Price Est 5 yr Growth Earnings to Price (IBES) (on IBES 1 yr est) S&P/BARRA Yes No No Half market cap in each index Reconstituted 1/1 & 7/1 Russell U.S. Yes Yes No 70% of stocks are Growth or Value

30% of stocks partly in both Reconstituted 6/30 Russell non-U.S. PB, P/Cash Flow, PE, IBES 5yr est growth equal weighted scores within country Stocks are either growth or value MSCI Yes No No Wilshire Yes No Yes Score = 75% B/P + 25% E/P Half market cap in each index Reconstituted in June Salomon Growth Stocks have high: 5 yr EPS, Sales Growth

Retained ROE Value Stocks have high: B/P, Cash Flow/P, Sales/P, Yield

Roughly 25% of names and 50% of Cap is all Growth or Value, remainder are probability weighted in both indexes

Prudential Growth Stocks have: Sales growth > 10% IBES Est 5 yr Growth > Median Low Dividend Payout Low Debt/Capital Value Stocks have: Earnings/Price > Median Dividends constant or rising Thus, the benchmarks are different, but most of them rely heavily on Book to Price. While simple, this approach may not be relevant. All the style indexes, however, ignore the real complexity of money management. Value investors do more than seek simple cheapness as measured by BP or EP, and growth investors don’t just look for expensive stocks. Oversimplification of the definitions of Growth and Value can cause unreasonable distortions of the asset allocations of institutional investors. Fundamentals A study by Chicago Investment Analytics, Spring 2000, looked at the underperformance of Value stocks and measured fundamental differences between Value and Growth (based on Earnings/Price) in the top 1000 stocks going back to the mid-1980s. They found, for example, that value stocks have generally had estimated future growth rates of 10%, whereas for growth stocks the estimated growth rate has recently accelerated from 20% to 29%. Similar relative improvements on the part of growth stocks were also found in Sales Growth (see Table 1), Earnings Surprises and Estimate Revisions. Table 1 Value Value Growth Growth Historically Now Historically Now 5 Year Estimated EPS Growth 10% Same 20% 29% Annual Sales Growth 6-7% Same 15% 29% Positive Earnings Surprises 53% Same 54% 70% % upward EPS Revisions 45% 42% 43% 58% While the market may have overreacted, nevertheless, there have been fundamental improvements behind the recent out-performance of Growth versus Value. What do we mean by “value”? One problem is with Value investing is this word “Value”. When we use the term value in our daily lives, we generally mean it as a measure of quality relative to price, (or quality per dollar: Value = Quality / $).

Price itself determines whether a coat or a car is cheap or expensive, but price does not determine whether it is a good value. One can trade off price and quality in the same way we do Risk and Return in the Efficient Frontier of investing. Thus, we can think in terms of a Quality Frontier for every product we buy: If we pay a little more, we should get something that is better quality. In an ideal world, value would be perfectly calibrated to price, as in the opening quote about cigars. However, in most areas of the economy, the quality frontier is not a straight line, but rather an upward sloping curve which reflects diminishing returns in quality as the price goes higher. (A Cadillac is a little better than a Chevrolet, but a Chevrolet is a lot better than walking). While the slope of a quality curve flattens at higher prices, the behavior of our preferences is just the opposite. For each person, we can construct Utility Functions which are curves of equal value. We make a purchase when our Utility Function touches the Quality Frontier. The shape of our Utility Function will change on days when we feel richer or poorer, but often we may find the value of two products (a Ford and a Mercedes) to be similar even though one is expensive and the other cheap. Thus the Value of a product is not its price or cheapness, but rather its Quality compared to its Price (V = Q/P). Figure 3

Value Framework

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In the world of investing, however, Value is commonly represented as the amount of Earnings, Dividends or Book Value per dollar of Price. When some investors talk about “value” stocks, they are simply talking about cheap stocks. They are saying nothing about the quality of those stocks. In fact, Growth is not the opposite of Value, any more than growth investors set out to buy stocks that are bad values. Today, most institutional investors behave in very similar ways: They all get the same news feeds, databases and street research, and they all cover most aspects of classical Graham & Dodd research. Real information advantages are scarce (particularly given the SEC’s rules on non-public information). Thus, differences among investment firms are more in where they focus the emphasis of their work rather than what they leave out completely. They all build portfolios based on the same basic steps: Acquisition of information, the estimation of future streams of earnings, dividends and cash flows, the estimation of asset values and the estimation of risk. These results are then compared with a stock price to reach a buy, sell or

hold decision. A “laundry” list of analytical tools and activities is shown in Table 2, below. Value mangers are likely to focus more on those at the top of the list; while growth managers spend more time on those at the bottom. Table 2 Accounting Measures

Earnings Dividends Cash Flow Book Value Asset and Liability Valuation Accounting analysis

Valuation Models Discount Models: Discount rates, fade rates, sustainable growth rates Fade Rates Enterprise Value Added, cost of capital Cash Flow Return on Investment, replacement cost, present value of Plant & Equipment Price Targets GARP, PE versus Growth Rate

Subjective Fundamental Measures Management Quality Alliances Research & Development New Products Strategy Growth Measures

Earnings Growth Sales Growth Cash Flow Growth Retained Return on Equity

Change Measures Estimate Revisions Earnings Surprises Fundamental Catalysts Price Momentum

Evolution of the Economy The stock market and the economy have changed greatly since Graham and Dodd wrote Security Analysis in 1934. At that time, many stocks were depressed below their liquidation value. Some even had liquid assets in excess of their market capitalizations. By the 1960s most of these values had disappeared, but America still dominated many capital-intensive industries. And as a result, many stocks with low Price/Book did well. In the late 1970s, our competitive economic position had eroded, but many basic industry stocks benefited from the inflationary global boom in commodity prices. Then in the late 1980s many industrial stocks benefited from aggressive restructurings, which improved margins and unlocked values. Today, however, many easy gains from security analysis have been realized. The stock market is more efficient. Also, unfortunately, the global competitive outlook for companies in many traditional U.S. industries is not good. More than ten years ago, management consultant Peter Drucker predicted the rise of new Knowledge-based companies to replace the dominance of the old, mature Production and Manufacturing-based companies in our economy. This forecast has come true. There has been enormous vitality and innovation in Knowledge-based companies in technology, health care and financial services.

This has produced strong job growth in the U.S., although many jobs in the Old Economy” sectors of manufacturing and production have disappeared. Today, the economic position of the U.S. is strong globally, not because we have protected our Old Economy companies, but because we have stimulated the New Economy companies. Unfortunately, this evolution in economic leadership has presented challenges to investors. One challenge is that historical cost accounting may be less reliable for comparing values today because it treats New Economy and Old Economy companies unevenly. In the Old Economy, hard assets iof manufacturing and production companies have had measurable useful lives for depreciation purposes, often specified by tax codes. Today, however, those lives can be shortened unpredictably by technological obsolescence. This can cause Old Economy companies to overstate their assets, book values and earnings. Meanwhile the assets of Knowledge-based companies in the New Economy have assets which may be understated, because they are hard to quantify from an accounting standpoint. Innovations, patents, goodwill, R&D, brand, employees and market share are all unrecognized or understated under GAAP accounting. Because of these distortions, accounting data has lost some of its power in identifying stock market values. Another challenge comes from the intense competitive dynamics of many New Economy industries. Michael Price (XXXXXrefrenceXXX) in the Gorilla Game described this as a “winner take all” environment. It is driven by the economics of products where development costs are high but production costs are low, as in computer software. In these types of businesses, the goal is to gain a monopoly by lowering prices to discourage competitors while gaining enough volume to offset the initial costs. Companies that can gain an edge in market share can then drive out the competition, as VHS video-recorders did with Betamax. Treasury Secretary Larry Summers describes this an “accelerator” economic model (where higher production volume lowers production costs, encouraging lower prices, which increase demand and lead to still higher production volume). This can be contrasted with the “thermostat” model of the Old Economy (where higher production volume meets capacity limitations, increasing costs and thus reducing customer demand). In a “winner take all” environment, the law of “regression to the mean” does not work. Companies which are losers will always look like great values, while their fundamentals continue to deteriorate. Jack Welsh at GE pioneered the strategy of leadership in every business., and in the competitive New Economy, this is a fundamental strategy. In the New Economy, response to change is crucial, and history is a poor guide to the future. Just because a stock or industry is selling at a new all-time low valuation on Book to Price does not mean that it will revert to its historic valuation. Evolution of Investment Styles In this changed environment, investors have responded with new approaches to valuation, often pioneered by new “maverick” firms. With success, some of these disciplines have been copied and incorporated into the mainstream. The result has been a multiplicity of investment styles that goes far beyond the original simple framework of Value versus Growth. It is time to think of a new landscape of investment styles, which can encompass new developments in valuation techniques and can recognize that “value” can be found in many ways and in many places in the market. What really separates investors is not a difference in their commitment to finding good values; it is differences in their willingness to look out into the future, to accept growth. If they are doubters, they will be skeptical about future growth. The time horizons of their analysis will be short, and they will focus more on current earnings and assets. They will spend less time assessing the impact or the likelihood of long term growth. As a result, their portfolios will have stocks with lower growth rates, where the payback for investing is more immediate. Other investors, however, are more willing to believe in forecasts. They look forward over long time horizons, and they have more confidence in their ability to identify the potential of a company’s products in the future. These investors will own companies with higher future growth rates. Therefore, in constructing a framework for discussing and comparing investment styles, we can use a scale based on the growth rates of stocks in managers’ portfolios, from low to high. This reflects the time horizon managers use in their analysis, but is easier to measure. For this scale of growth, we can use IBES Estimated 5 year growth, possibly combined with historical sales growth (already Russell uses IBES

Estimated 5 year Growth as one of its measures, and Prudential uses both IBES Estimated 5 year Growth and historic sales growth). In addition to this horizontal growth scale, however, we suggest measuring managers on a vertical axis scale which would capture the trend of recent positive and negative changes in fundamentals. The resulting framework is presented in the Style Map below: Figure 4

This Style Map has several features: 1) On the horizontal “Growth Axis”, Low Growth/Short Horizon and High Growth/Long Horizon are the extremes, capturing the relative optimism or skepticism of investors about the future. Over time, the median of the population of investors will shift to the right or left depending on the stability of the outlook (in 1999, it shifted to the right with a vengeance; but five years ago, due to the Fama and French paper endorsing “value” stocks, median manager probably moved toward the left). 2) On the vertical “Trend Axis”, Positive Change and Negative Change identify investors who tend toward being either trend followers or contrarians. Generally, however, only retail investors and a few quantitative investors would be at the upper or lower extremes of Momentum or Contrarian Styles. At these extremes, analysis is primarily Technical rather than Fundamental. Thus, the Ellipse is drawn to define the limits of Fundamental Analysis, with pure Technical Analysis roaming beyond its frontier. 4) Analytical Tools are shown in Red:

1) Yield is the province of Deep Value investors. It drives portfolios into low growth stocks and often stocks which have become particularly cheap because of negative fundamental changes (the highest yields often come just before dividend cuts).

2) Book to Price and Earnings to Price are used most heavily by the index providers and academics. Lately, however, they have developed several accounting pitfalls mentioned above. Rapidly growing companies are often penalized by write-offs of advertising, R&D and goodwill; while slower growing capital intensive companies may not be writing off assets quickly enough, leading to understatement of their depreciation and overstatement of their book values. As the U.S. economy moves from a production base to a knowledge base, these distortions have widened the gap in accounting between traditional value and growth stocks.

3) EV/EBITDA (Enterprise Value / Earnings Before Interest, Taxes and Depreciation) has grown in popularity recently. Because it adds debt and equity together, enterprise value is less sensitive to negative relative price strength than B/P or E/P, but the addition of interest and depreciation to pretax earnings causes a bias in favor of capital-intensive companies.

4) Fundamental Catalysts have been sought for many years by value managers in order to avoid buying declining stocks too early. Now catalysts are widely discussed all investors as early buy signals.

5) DDM, CFROI and EVA are quantitative valuation models which have been widely adopted. While often conceptually accurate, they suffer in practice from estimation difficulties. Discount models, for example, are extremely sensitive to estimates of the duration of growth, the fade rate of growth, the terminal growth rate and the discount rate.

6) Earnings Surprises and Estimate Revisions are powerful indicators of positive change. The power of Estimate Revisions has been confirmed by studies in behavioral finance, which have found that analysts tend to “anchor” their estimates to their previous number and thus under-react to new information. This effect is likely to continue to be important. Earnings Surprises, however, may lose some of their power as they fall victim to the game between managements and analysts over quarterly estimates. While companies talk down their expectations so they can report a positive surprise, analysts have begun to withhold their best estimates from published databases so they can tell their favored clients their higher “whisper” number. Recently, the market has become more volatile as the SEC’s Fair Disclosure rule has prompted companies to reduce the flow of information.

5) Investment Styles are shown in Blue Italics:

a. Deep Value, Absolute Value, Traditional Value and Yield-Based Value are the oldest value styles, which rely on relatively short forecasting horizons. They have been challenged in the recently volatile market..

b. Flexible Value and Relative Value are more moderate styles, which have performed somewhat better then Deep Value. They may seek bargains across industries and sectors or they may seek companies which are historically cheap. This approach may underestimate the importance of leadership in some industries.

c. E) GARP (Growth at a Reasonable Price), is shown as a diagonal line moving down to the right. This style can buy stocks across a broad range of growth rates, but among higher growth rate stocks, it typically looks for cheapness. Unfortunately, some of these stocks are cheap for a reason….they are suffering negative change.

d. F) Traditional Growth and Earnings Momentum Growth are on the right, differing in the degree of their interest in positive change.

Investors have been successful at recognizing when old valuation tools are no longer useful and developing new tools to gain an edge over the “efficient” market. It is time to develop new tools as well for looking at investors and for understanding the differences in their styles. The traditional yardstick of Value versus Growth has always been flawed by the fact that growth is not the opposite of value, but rather an important element in it. Value and Growth are not dead, but the Style Map provides an opportunity to measure mangers more precisely, by the tools and the time horizons they use rather than by backward-looking accounting measures. Successful investors will lie in all quadrants of the Style Map. There is room in institutional investing for investors who seek strong or weak current trends and who seek high or low growth, using long or short horizons. REFERENCES Barton M. Biggs, “Value will out” Morgan Stanley Strategy and Economics, April 10, 1995

Carlo Capaul, Ian Rowley and William F. Sharpe, “International Value and Growth Stock Returns” Financial Analysts Journal, January-February 1993 W. Scott Bauman, C. Mitchell Conover and Robert E. Miller, “Growth versus Value and Large-Cap versus Small-Cap Stocks in International Markets”, Financial Analysts Journal, March/April 1998 Eugene F. Fama and Kenneth R. French, “Common Risk Factors in the Returns on Stocks and Bonds”, Journal of Financial Economics, 33, 1993 Benjamin Graham, David L. Dodd and Sidney Cottle, Security Analysis, New York: McGraw-Hill, Fourth Edition, 1962 Robert A. Haugen, “The Race Between Value and Growth”, The Journal of Investing, Spring 1997 J. Lakonishok, A. Shleifer, and R. Vishny, “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance December 1994 Richard O. Michaud, “Is Value Multidimensional? Implications for Style Management and Global Stock Selection” Journal of Investing 1997 Ernesto Ramos & Lawrence Speidell, “Do Estimate Revisions Work in International Markets”, The Journal of Investing, Spring 1998 Dennis Trittin, “Value Tilts - Why the Free Lunch and the Active Manager Enigma?”, Russell Research Commentary, November 1994 David A. Umstead, “International Equity Style Management”, Equity Style Management, Chicago: Irwin Professional Publishing, 1995 Richard S. Yeh and Yazid M. Sharaiha, “Global Style Investing with MSCI Value and Growth Indices”, Global Equity and Derivative Markets, Morgan Stanley Dean Witter, December 1997 Robert D. Barkley, of Barrow, Hanley, Mewhinney & Strauss Inc., “Style allocation drift”, Pensions & Investments, April 17, 2000 Robert J. Pelosky and Hernando Cortina, Morgan Stanley, Global Strategy, MacroMorphosis, March 22, 2000 Peter Drucker, “Putting more now into knowledge”, Forbes Magazine, May 15, 2000

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co

un

ts

Ca

pit

ali

ze

d b

y Q

ua

rte

rly

Av

era

ge

10

-Ye

ar

Bo

nd

Yie

ld

10

10

0

10

00

70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

20

00

Index, Q1 1991 = 100

Pro

fits S

&P

50

01

00

20

0

30

0

Wha

t is

Valu

e?W

hat i

s Va

lue?

Pric

e C

hang

e Fo

llow

s Ea

rnin

gs

Pric

e C

hang

e Fo

llow

s Ea

rnin

gs

Gro

wth

Gro

wth

Dec

ile M

edia

n Fi

ve Y

ear H

isto

rical

Ear

ning

s G

row

th

and

Five

Yea

r Ann

ual R

etur

n

-20

-10010203040

-40

-30

-20

-10

010

2030

4050

60

Five

Yea

r His

toric

al E

arni

ngs

Gro

wth

Five Year Annual Return

1997

EAFE

ex

Japa

n

Japa

n

Uni

ted

Stat

es

Wha

t is

NO

T Va

lue…

.W

hat i

s N

OT

Valu

e….

Gro

wth

Est

imat

es F

ollo

w H

isto

rical

G

row

th E

stim

ates

Fol

low

His

toric

al

Earn

ings

Earn

ings

Dec

ile M

edia

n Fi

ve Y

ear H

isto

rical

Ear

ning

s G

row

th

and

Long

Ter

m G

row

th E

stim

ate

05101520

-50

-25

025

5075

Five

Yea

r His

toric

al E

arni

ngs

Gro

wth

Long Term Growth Estimate

1997

EAFE

ex

Japa

n

Japa

nU

nite

d St

ates

Wha

t is

NO

T Va

lue…

Wha

t is

NO

T Va

lue…

Pric

e to

Boo

k Fo

llow

s H

isto

rical

Pr

ice

to B

ook

Follo

ws

His

toric

al

Earn

ings

Earn

ings

Dec

ile M

edia

n Fi

ve Y

ear H

isto

rical

Ear

ning

s G

row

th

and

Pric

e to

Boo

k R

atio

01234 -50

-25

025

5075

Five

Yea

r His

toric

al E

arni

ngs

Gro

wth

Price to Book Ratio

1997

EAFE

ex

Japa

n

Japa

n

Uni

ted

Stat

es

Wha

t is

NO

T Va

lue

or G

row

th…

Wha

t is

NO

T Va

lue

or G

row

th…

Hig

h Pr

ice

to B

ook

Som

etim

es H

as H

igh

Hig

h Pr

ice

to B

ook

Som

etim

es H

as H

igh

Est

Est

Gro

wth

Gro

wth

Dec

ile M

edia

n Es

timat

ed L

ong

Term

Gro

wth

an

d Pr

ice

to B

ook

Rat

io

0123456

010

2030

40

Estim

ated

Lon

g Te

rm G

row

th

Price to Book Ratio19

97

EAFE

ex

Japa

n

Japa

n

Uni

ted

Stat

es

Wha

t is

NO

T Va

lue

or G

row

th…

Wha

t is

NO

T Va

lue

or G

row

th…

Hig

h Pr

ice

to B

ook

Som

etim

es H

as H

igh

Hig

h Pr

ice

to B

ook

Som

etim

es H

as H

igh

Est

Est

Gro

wth

Gro

wth

Wha

t is

NO

T G

row

th o

r Val

ue…

Wha

t is

NO

T G

row

th o

r Val

ue…

Hig

h Pr

ice

to B

ook

is S

omet

imes

Hig

h H

igh

Pric

e to

Boo

k is

Som

etim

es H

igh

Est

Est

Gro

wth

Gro

wth

Top

Dec

ile o

f Com

pani

es

by L

ong

Term

Gro

wth

Est

imat

e, 1

997

0%25%

50%

75%

100%

5.2

US

3.0

Japa

n2.

1EA

FE exJa

pan

Percent in Sector

Man

ufac

turi

ng

Tran

spor

t, En

ergy

& U

tiliti

es

Cons

umer

, Ret

ail &

Fin

ance

Com

mer

cial

Ser

vice

s

Tech

nolo

gy &

Hea

lth S

ervi

ces

PB R

atio

Wha

t is

NO

T G

row

th…

Wha

t is

NO

T G

row

th…

Pric

e to

Boo

k D

oes

Not

Pre

dict

Ear

ning

s Pr

ice

to B

ook

Doe

s N

ot P

redi

ct E

arni

ngs

Gro

wth

Gro

wth

Pric

e to

Boo

k D

ecile

ver

sus

One

and

Fiv

e Ye

ar A

ctua

l Ear

ning

s G

row

th

-15

-10-505101520

12

34

56

78

910

Pric

e to

Boo

k D

ecile

Actual Earnings Growth19

85-1

992

EAFE

ex

Japa

n - 5

Yea

r, 1

Year

Japa

n - 5

Yea

r, 1

Year

US

- 5 Y

ear,

1 Ye

ar

Wha

t is

NO

T G

row

th…

Wha

t is

NO

T G

row

th…

LTG

Est

imat

es D

o N

ot P

redi

ct E

arni

ngs

LTG

Est

imat

es D

o N

ot P

redi

ct E

arni

ngs

Gro

wth

Gro

wth

Estim

ated

Lon

g Te

rm G

row

th D

ecile

ver

sus

One

and

Fiv

e Ye

ar A

ctua

l Ear

ning

s G

row

th

-25

-20

-15

-10-50510152025

12

34

56

78

910

Estim

ated

Lon

g Te

rm G

row

th D

ecile

Actual Earnings Growth

1985

-199

2

EAFE

ex

Japa

n -

5 Ye

ar, 1

Yea

r

Japa

n - 5

Yea

r, 1

Year

US

- 5

Year

, 1 Y

ear

Wha

t is

Valu

e?W

hat i

s Va

lue?

Val

ue

Fra

mew

ork

Pri

ce

Quality

Qu

alit

y F

ron

tier

s

1970

2000

Valu

e =

Qua

lity

/ Pric

eVa

lue

= Q

ualit

y / P

rice

Val

ue

Fra

mew

ork

Pri

ce

Quality

Uti

lity

Fu

nct

ion

s

Qu

alit

y F

ron

tier

Bu

y P

oin

t

Wha

t is

Inve

stm

ent Q

ualit

y?W

hat i

s In

vest

men

t Qua

lity?

Man

agem

ent

Acc

ount

ing

Mar

ket R

isk

Spec

ific

Ris

kTr

ansp

aren

cyVi

sibi

lity

Gro

wth

Man

agem

ent

Acc

ount

ing

Mar

ket R

isk

Spec

ific

Ris

kTr

ansp

aren

cyVi

sibi

lity

Gro

wth

Qua

lity

Issu

es in

Acc

ount

ing

Qua

lity

Issu

es in

Acc

ount

ing

Old

Eco

nom

yO

bsol

esce

nce

Ass

et V

alue

sD

epre

ciat

ion

Rat

es

New

Eco

nom

yM

atch

ing

Cos

ts w

ith R

even

ues

R&

DA

dver

tisin

gG

oodw

ill

Old

Eco

nom

yO

bsol

esce

nce

Ass

et V

alue

sD

epre

ciat

ion

Rat

es

New

Eco

nom

yM

atch

ing

Cos

ts w

ith R

even

ues

R&

DA

dver

tisin

gG

oodw

ill

Qua

lity

Issu

es in

Cor

pora

te

Qua

lity

Issu

es in

Cor

pora

te

Stra

tegy

Stra

tegy

Geo

ffrey

Moo

re’s

The

orum

(Gor

illa

Gam

e)

Win

ner T

akes

All

Lose

rs w

ill a

lway

s lo

ok li

ke G

reat

Va

lues

Ret

urns

reve

rt to

the

extr

eme

Geo

ffrey

Moo

re’s

The

orum

(Gor

illa

Gam

e)

Win

ner T

akes

All

Lose

rs w

ill a

lway

s lo

ok li

ke G

reat

Va

lues

Ret

urns

reve

rt to

the

extr

eme

Qua

lity

Issu

es in

Cor

pora

te

Qua

lity

Issu

es in

Cor

pora

te

Stra

tegy

Stra

tegy

Larr

y Su

mm

ers:

“Th

erm

osta

t ver

sus A

vala

nche

”

Old

Eco

nom

y –

“Neg

ativ

e Fe

edba

ck”

Star

t-up

Cos

t: $1

00,0

00U

nit C

ost:

$1,0

00 –

falli

ng, t

hen

risin

gN

ew E

cono

my

–“P

ositi

ve F

eedb

ack”

Star

t-up

Cos

t: $1

Mil

Uni

t Cos

t: $1

-co

nsta

nt

Old

Eco

nom

y –

“Neg

ativ

e Fe

edba

ck”

Star

t-up

Cos

t: $1

00,0

00U

nit C

ost:

$1,0

00 –

falli

ng, t

hen

risin

gN

ew E

cono

my

–“P

ositi

ve F

eedb

ack”

Star

t-up

Cos

t: $1

Mil

Uni

t Cos

t: $1

-co

nsta

nt

Qua

lity

Issu

es in

Cor

pora

te

Qua

lity

Issu

es in

Cor

pora

te

Stra

tegy

Stra

tegy

Larr

y Su

mm

ers:

“Th

erm

osta

t ver

sus A

vala

nche

”

110100

1000

1000

0

1000

00

1000

000

1000

0000

1000

0000

0

1000

0000

00

025

5075

100

125

150

175

Uni

ts

Costs

Old

Eco

nom

y C

ost/U

nit =

$1,

000+

Old

Eco

nom

y To

tal C

osts O

ld A

vg C

ost/U

nit

Old

Eco

nom

y: R

isin

g V

olum

e =

Ris

ing

Pric

es =

Low

er D

eman

d

Qua

lity

Issu

es in

Cor

pora

te

Qua

lity

Issu

es in

Cor

pora

te

Stra

tegy

Stra

tegy

Larr

y Su

mm

ers:

“Th

erm

osta

t ver

sus A

vala

nche

”

110100

1,00

0

10,0

00

100,

000

1,00

0,00

0

10,0

00,0

00

100,

000,

000

1,00

0,00

0,00

0

025

5075

100

125

150

175

Uni

ts

Costs

Old

Cos

t/Uni

t =

$1,0

00+

New

Cos

t/Uni

t = $

1

New

Avg

Cos

t/Uni

t

New

Tot

al C

osts

Old

Tot

al C

osts

Old

Avg

Cos

t/Uni

t

New

Eco

nom

y: M

onop

olie

s may

be

OK

….

Qua

lity

Issu

es in

Cor

pora

te

Qua

lity

Issu

es in

Cor

pora

te

Stra

tegy

Stra

tegy

Old

Eco

nom

yN

ew E

cono

my

Pre-

1999

1999

-fu

ture

Info

rmat

ion

scar

city

val

ueIn

form

atio

n ov

erlo

adLe

ngth

y ge

stat

ion

Acc

eler

ated

dis

coun

ting

Mor

e is

bet

ter

Thin

is in

Long

-term

fore

cast

ing

Rea

l-tim

e fo

reca

stin

gH

isto

ry le

ads t

he fu

ture

Futu

re w

ithou

t his

tory

Prop

rieta

ry w

ork

Col

labo

ratio

n/al

lianc

esD

ispa

rate

dis

clos

ure

Glo

bal s

tand

ards

Cou

ntry

/regi

on a

lloca

tion

One

wor

ld se

ctor

sele

ctio

n

Sour

ce: M

orga

n St

anle

y

Qua

lity

Issu

es in

Cor

pora

te

Qua

lity

Issu

es in

Cor

pora

te

Stra

tegy

Stra

tegy

Old

Eco

nom

yN

ew E

cono

my

Pre-

1999

1999

-fu

ture

Info

rmat

ion

scar

city

val

ueIn

form

atio

n ov

erlo

adLe

ngth

y ge

stat

ion

Acc

eler

ated

dis

coun

ting

Mor

e is

bet

ter

Thin

is in

Long

-term

fore

cast

ing

Rea

l-tim

e fo

reca

stin

gH

isto

ry le

ads t

he fu

ture

Fut

ure

with

out h

isto

ryPr

oprie

tary

wor

kC

olla

bora

tion/

allia

nces

Dis

para

te d

iscl

osur

eG

loba

l sta

ndar

dsC

ount

ry/re

gion

allo

catio

nO

ne w

orld

sect

or se

lect

ion

Sour

ce: M

orga

n St

anle

y

Qua

lity

Issu

es in

Cor

pora

te

Qua

lity

Issu

es in

Cor

pora

te

Stra

tegy

Stra

tegy

Res

pons

e to

Cha

nge…

Cru

cial

Hig

h an

d Lo

w G

row

th…

OK

His

toric

al A

ccou

ntin

g… L

ess

Valu

able

Reg

ress

ion

to th

e M

ean…

Unr

elia

ble

Res

pons

e to

Cha

nge…

Cru

cial

Hig

h an

d Lo

w G

row

th…

OK

His

toric

al A

ccou

ntin

g… L

ess

Valu

able

Reg

ress

ion

to th

e M

ean…

Unr

elia

ble

Land

scap

e of

Sty

le:

Land

scap

e of

Sty

le:

Hig

h G

row

th a

nd L

owH

igh

Gro

wth

and

Low

Trad

ition

al V

alue

Trad

ition

al, C

onsi

sten

t Gro

wth

Low

Gro

wth

Hig

h G

row

th

Land

scap

e of

Sty

le:

Land

scap

e of

Sty

le:

Gro

wth

& T

ime

Gro

wth

& T

ime

Trad

ition

al V

alue

Trad

ition

al, C

onsi

sten

t Gro

wth

Low

Gro

wth

Shor

t Hor

izon

Hig

h G

row

thLo

ng H

oriz

on

Land

scap

e of

Sty

le:

Land

scap

e of

Sty

le:

Gro

wth

& C

hang

eG

row

th &

Cha

nge

Posi

tive

Chan

geM

omen

tum

Cont

raria

n

Trad

ition

al V

alue

Low

Gro

wth

High

Gro

wth

Nega

tive

Chan

ge

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

Trad

ition

al, C

onsis

tent

Gro

wth

Posi

tive

Chan

geM

omen

tum

Cont

raria

n

Trad

ition

al V

alue

Low

Gro

wth

High

Gro

wth

Nega

tive

Chan

ge

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

Trad

ition

al, C

onsis

tent

Gro

wth

Long

Hor

izon

Shor

t Hor

izon

Land

scap

e of

Sty

le:

Land

scap

e of

Sty

le:

Tool

s of

the

Trad

eTo

ols

of th

e Tr

ade

Posi

tive

Chan

geM

omen

tum

Cont

raria

n

Trad

ition

al V

alue

Deep

Val

ue

Trad

ition

al, C

onsis

tent

Gro

wth

Estim

ate

Revi

sions

DDM

, CFR

OI, E

VA, R

ROE

Low

Gro

wth

Shor

t Hor

izon

High

Gro

wth

Long

Hor

izon

Nega

tive

Chan

ge

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

EV/E

BITD

A

Yiel

d

Earn

ings

Sur

prise

s

Fund

amen

tal C

atal

ysts

PE B

ased

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

EP B

P

Posi

tive

Chan

geM

omen

tum

Cont

raria

n

Trad

ition

al V

alue

Deep

Val

ue

Trad

ition

al, C

onsis

tent

Gro

wth

Estim

ate

Revi

sions

DDM

, CFR

OI, E

VA, R

ROE

Low

Gro

wth

Shor

t Hor

izon

High

Gro

wth

Long

Hor

izon

Nega

tive

Chan

ge

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

EV/E

BITD

A

Yiel

d

Earn

ings

Sur

prise

s

Fund

amen

tal C

atal

ysts

PE B

ased

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

EP B

P

Land

scap

e of

Sty

le:

Land

scap

e of

Sty

le:

A M

osai

c of

Man

ager

sA

Mos

aic

of M

anag

ers

Posi

tive

Chan

geM

omen

tum

Flex

ible

Val

ue Cont

raria

n

Trad

ition

al V

alue

Rela

tive

Valu

e

Deep

Val

ue

Trad

ition

al, C

onsis

tent

Gro

wth

Estim

ate

Revi

sions

DDM

, CFR

OI, E

VA, R

ROE

Low

Gro

wth

Shor

t Hor

izon

High

Gro

wth

Long

Hor

izon

Nega

tive

Chan

ge

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

GARP

GARP

EV/E

BITD

A

Yiel

d

Earn

ings

Sur

prise

s

Fund

amen

tal C

atal

ysts

PE B

ased

Earn

ings

Mom

entu

m G

rowt

h

Tech

nica

l Ana

lysi s

Tech

nica

l Ana

lysis

EP B

P

Posi

tive

Chan

geM

omen

tum

Flex

ible

Val

ue Cont

raria

n

Trad

ition

al V

alue

Rela

tive

Valu

e

Deep

Val

ue

Trad

ition

al, C

onsis

tent

Gro

wth

Estim

ate

Revi

sions

DDM

, CFR

OI, E

VA, R

ROE

Low

Gro

wth

Shor

t Hor

izon

High

Gro

wth

Long

Hor

izon

Nega

tive

Chan

ge

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

GARP

GARP

EV/E

BITD

A

Yiel

d

Earn

ings

Sur

prise

s

Fund

amen

tal C

atal

ysts

PE B

ased

Earn

ings

Mom

entu

m G

rowt

h

Tech

nica

l Ana

lysis

Tech

nica

l Ana

lysis

EP B

P

Land

scap

e of

Sty

le:

Land

scap

e of

Sty

le:

Rec

ent R

esul

tsR

ecen

t Res

ults

Con

clus

ions

Con

clus

ions

His

toric

al A

ccou

ntin

g… L

ess

Valu

able

Reg

ress

ion

to th

e M

ean…

Unr

elia

ble

Res

pons

e to

Cha

nge…

Cru

cial

Hig

h an

d Lo

w G

row

th…

OK

Valu

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wth

are

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d…th

ey a

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e sa

me!

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toric

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elia

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cial

Hig

h an

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row

th…

OK

Valu

e &

Gro

wth

are

Not

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d…th

ey a

re th

e sa

me!

Land

scap

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le:

Land

scap

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le:

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sA

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aic

of M

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sions

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VA, R

ROE

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Gro

wth

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wth

Long

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tive

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Tech

nica

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lysis

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nica

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lysis

GARP

GARP

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BITD

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d

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ings

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prise

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tal C

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ased

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entu

m G

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nica

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P

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omen

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ROE

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wth

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wth

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tive

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Tech

nica

l Ana

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lysis

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prise

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ased

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EP B

P