DFA Founder David Booth on Value Stocks' Comeback

(Money) David Booth became a billionaire patiently adhering to a philosophy of betting undervalued stocks. Over that past several years that patience has been tested as so-called value stocks endured one of their worst stretches in memory. Now Booth says those stocks are making a comeback — even as he doubts the stock market, powered by the runaway gains of tech and other growth stocks, is in a bubble.

Booth co-founded his private investment firm Dimensional Fund Advisors (DFA) in 1981 from the spare bedroom of his Brooklyn apartment. He took an academic approach to investing after studying at the University of Chicago under a professor who would eventually win the Nobel Prize for research on the “efficient market hypothesis” — which essentially says you can’t beat the market. Since then, Booth has become a staple in the value investing world and DFA has grown to have $637 billion in assets under management and more than 1,400 employees. After four decades, the firm sticks to the same basic principle: investors can’t beat the market, but they can lean into factors like value and profitability, eyeing stocks that have a higher value on the books than the cheap price they’re trading at on the market.

Value investors, though, have recently been disappointed as fast-growing companies like Netflix and Amazon have driven stock market returns. From August 2006 to mid-April 2021, the Russell 3000 Value Index has lagged behind the Russell 3000 Growth Index by 5.61 percentage points a year, according to Morningstar. While value stocks have just recently made a small comeback, it’s too early to tell if the pendulum is actually swinging that way again.

So should investors give up on value stocks for good? Is the stock market about to burst? Is the crypto frenzy dangerous? Here’s Booth on all that and more. (This interview has been edited and condensed for clarity.)

Are we in a stock market bubble?

No. Individuals have great short-term memory; markets typically don’t. Markets go up and go down, and they go up and down in unpredictable ways. In the last 10 years, we frequently had people call in saying, “The market’s near its all-time high, what do you think?” Well, I think there’s kind of an order in the universe: stocks have a higher expected return than bonds and bonds have a higher expected return than money market instruments. That’s the way it works out over long periods of time.

What moves should investors make right now?

If you say, “Well, what about the short term?” — trying to get on short-term market movements is more like gambling. The last year, if anything, has shown the tremendous cost of trying to time those things and not getting it right. At the end of March last year, a lot of people got out of the stock market and it has done over 60% since then. You want to have a long-term focus, something you can stick with. People talk about the “new normal” all the time, and if we look somewhere in the future, it will be the next normal too. It’s about uncertainty and sources of uncertainty change over time but the marketplace does a really good job of sorting through that.

Is value investing really dead?

Over the long haul, research shows that value stocks on average outperform growth. We think there’s a good reason for that. It’s lower-priced stocks and basically the lower price you pay for something the higher the eventual return. In the last few years it hasn’t been there — that’s kind of the nature of premiums in general. But over the last year, it’s been really quite different. Value has come back the way we think it ought to. At the end of the day, it’s always about uncertainty. If there is no uncertainty about the future, then your investment return would be basically a money market, a riskless asset return. On one hand, people shrink away from uncertainty, naturally, and on the other hand, it’s uncertainty that creates the opportunity to do better than a money-market-type of fund. During the first decade of this millennium, when value was doing really well, we didn’t shout our lungs out. If you’re a value investor you have to be prepared for those kinds of times when they’re going to underperform.

Has the definition of a value stock changed overtime?

Value is kind of in the eye of the beholder. We started our value strategies in 1992 and typically rely on price-to-book. Other people have come in with other definitions and a lot of them have advantages. The reason we like price-to-book primarily is it typically ends up with lower turnover rates and it’s also less manipulatable. Earnings have a better chance of being manipulated; There are ways of smoothing earnings that aren’t there with book value.

What about Bitcoin? Will it stick around, or is it a bubble?

I don’t think it’s a bubble, but it’s kind of like a gambling casino. There’s really no income that comes from Bitcoin, so you really just have to bet that if you’re buying it, it goes up. I think there are some great opportunities for Bitcoin and I think there are some major concerns. It’s a speculative investment and speculative investments tend to go up and down. Starting with the tulip bulbs, over the last 600 years we’ve seen these things go up and down. I don’t know why Bitcoin would be any different, other than it’s still at a relatively early stage so you could make the argument that it’s going to be a long time before it’s fully priced. I’m not making that argument either, that’s just why I’m not forecasting it’s a bubble. But, you ought to be concerned about it.

Will the GameStop trading frenzy and other events like it change the way people invest?

No. Whatever your view is about investing, there are always some stocks or bonds that fall outside, that can’t be explained by your view of the world. GameStop is one of those things where you have enormous amounts of people betting that GameStop’s stock will go up and enormous amounts of people betting that it will go down. But by and large, so many of those are short-term investors which gets back to the idea that — to the extent that short-term investors are moving the price around — we always view that as gambling and we try to avoid that when we can.

Should investors worry about inflation?

I think we should be worried. I’m worried about inflation. When we started the firm, inflation was around 12% and treasury bonds were yielding over 10% — it was a different world 40 years ago. There’s no reason it can’t happen again. I’m not planning that it’s going to happen in the next 12 months, but if you’re a long-term investor, you’ve got to think about these long term issues: what happens if there’s inflation? What happens if there’s deflation? What happens if there are high interest rates? Figure out what your goals are, figure out the range of outcomes that can happen with different scenarios and then figure out which one seems sensible.


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