More on Growth vs. Value Investing

Theme and Background

This chapter continues the discussion from the previous quarter on the evolving definition of value investing. The author argues that the market commonly equates value investing with "buying companies with low growth, low valuations, and structural disadvantages," but Oakmark contends that "buying high-quality companies at average prices is also value investing." The article introduces Morningstar's Value-Growth Scores framework, illustrating that value and growth are not opposites but two independent continuums, and points out that the current classification system can create confusion in specific cases.

Core Views

• Value and growth are not mutually exclusive but two independent dimensions: A company can be both "cheap" and "high-growth," and Morningstar's scoring system encounters classification contradictions when dealing with such companies.
• The current appeal of low P/E and low P/B stocks is above historical averages: The P/E spread is at an unusually high level, meaning low-valuation stocks offer greater investment value relative to growth stocks.
• Oakmark's investment actions are unrelated to classification labels: Even if Morningstar's scores push the fund toward the "blend" or even "growth" category, Oakmark will not alter its stock selection logic as a result, instead strengthening communication to avoid investor misunderstanding.

Key Arguments and Data

1. Contradictory Cases in Morningstar's Scoring System:

• First Citizens: Trades at roughly tangible book value and 8 times P/E (typical value indicators), but its earnings per share and book value have more than tripled in three years (a growth rate exceeding most popular growth stocks). Morningstar rates it as a growth stock close to Hilton (a high-growth stock).
• Liberty Broadband: Its primary asset is Charter stock, which Oakmark estimates is about 30% cheaper than Charter. However, due to GAAP accounting rules not reflecting Charter's market capitalization, its book value appears expensive, and Morningstar rates it closer to a growth stock than a value stock.
• Wells Fargo: Its P/E and P/B ratios are similar to First Citizens, but Morningstar's score places it at the lowest end of the value category.

2. Classification Risk for the Oakmark Select Fund:

• Due to concentrated holdings in First Citizens (6.6%) and Liberty Broadband (2.3%), rather than more Wells Fargo (3.7%) and Charter (4.6%), the fund's value-growth score sits at the borderline between value and blend. A slight increase in the score over the next few quarters could lead Morningstar to reassess its category classification.

3. Current Valuation Comparison for the Oakmark Fund:

Metric	Oakmark Fund	S&P 500
Weighted Average P/E (2024E)	10	18
Expected Growth Rate + Dividend Yield	Higher than S&P 500 consensus	—

• The fund pays less than 60% of the market's P/E ratio but has higher expected growth plus dividend yield.

4. Historical Reference:

• In 2022, Oakmark bought growth stocks that had fallen sharply in price, pushing the fund's score to blend levels.
• In 2023, after these growth stocks performed strongly, the fund sold them and bought low P/E stocks, causing the score to drop to its deepest value level since the 2000 dot-com bubble.

Companies/Assets Involved

Company	Role	Key Data	Bullish/Bearish
Hilton Worldwide	Representative high-growth stock	Oakmark bought when its P/E was close to the S&P 500; current holding 1.0% (Oakmark Fund)	Bullish, believes it should command a higher premium
Citigroup	Representative value stock	Score in negative territory; holding 1.6% (Oakmark Fund)	Bullish, believes the market has given up on it
First Citizens	Contradictory case of value and growth	Trades at roughly tangible book value and 8 times P/E; EPS and book value more than tripled in three years; Morningstar score close to Hilton	Bullish, one of Oakmark's most favored holdings
Charter Communications	Undervalued infrastructure company	Holding 2.2% (Oakmark Fund), 4.6% (Oakmark Select); Morningstar score as a value stock	Bullish, believes the market misjudges it as a dying cable TV company
Liberty Broadband	Cheaper alternative to Charter	About 30% cheaper than Charter; holding 1.0% (Oakmark Fund), 2.3% (Oakmark Select)	Bullish, but constrained by liquidity and size
Wells Fargo	Benchmark for value stock comparison	Holding 2.7% (Oakmark Fund), 3.7% (Oakmark Select); P/E and P/B similar to First Citizens but with a very low score	Bullish, but Oakmark prefers First Citizens

Investment Implications

• Investors should not judge a fund's style solely by Morningstar's classification labels: The Oakmark Select fund may be categorized as "blend" due to its holdings structure, but its actual investment logic remains deep value. If investors redeem based on classification changes, they may miss opportunities.
• The relative appeal of low-valuation stocks is currently at historical highs: The widening P/E spread suggests higher expected returns for value stocks (especially those with growth characteristics). The Oakmark fund, currently offering higher growth at 60% of the market's P/E, is a clear buy signal.
• Focus on "double discount" opportunities: For example, Liberty Broadband's 30% discount relative to Charter. Such structural discounts (due to accounting rules or liquidity) may provide an additional margin of safety.

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Theme and Background

This chapter continues the discussion on the definition of value investing, focusing on the contradictions in the practical application of Morningstar's Value-Growth Scores framework. Through specific case studies, the author points out that this framework classifies companies with strong fundamentals but depressed stock prices (e.g., Citigroup) as "value stocks," while classifying others with solid fundamentals and strong stock performance (e.g., Hilton) as "growth stocks." Such classification may mislead investors in their judgment of "cheap" versus "expensive."

Core Argument

The author's central thesis is that Morningstar's Value-Growth Scores framework is essentially a "price momentum" indicator, rather than a genuine tool for classifying value or growth. This framework tends to classify stocks with declining prices as "value stocks" and those with rising prices as "growth stocks," independent of fundamentals. The author argues that investors should not rely on such mechanical classifications but should instead return to the relationship between corporate fundamentals and price.

Counterintuitive judgment: Citigroup is classified as a "value stock" not because of its strong asset quality or low valuation, but because its stock price has been persistently depressed; Hilton is classified as a "growth stock" not because its growth prospects are superior to Citigroup's, but because its stock price has risen. This classification logic may lead investors to mistakenly believe that "value stocks" are inherently cheap and "growth stocks" are inherently expensive.

Key Arguments and Data

The author uses comparative data on Citigroup and Hilton to illustrate the confusion in classification:

Metric	Citigroup	Hilton Worldwide
Morningstar Classification	Value Stock	Growth Stock
Price-to-Earnings Ratio (P/E)	Approximately 10x	Close to S&P 500 average (approximately 20x)
Stock Performance (Last 3 Years)	Depressed, trading below book value	Rising, near historical highs
Fundamental Trend	Earnings volatile, weighed down by regulation and macro factors	Steady growth, benefiting from travel recovery

The author notes that Citigroup's P/E ratio is only 10x, far below Hilton's 20x, yet Morningstar classifies the former as a "value stock" and the latter as a "growth stock." This is not because Citigroup's assets are of higher quality or its growth is faster, but because its stock price decline has resulted in a relatively high book value (low P/B), leading the framework to deem it "value." Conversely, Hilton, due to its rising stock price and higher P/B, is deemed "growth."

The author further emphasizes that if investors buy "value stocks" (e.g., Citigroup) solely based on Morningstar's classification, they may face a value trap—where the depressed stock price reflects deteriorating fundamentals rather than market mispricing. Meanwhile, Hilton, though classified as a "growth stock," has a P/E ratio close to the market average and solid fundamentals, making it potentially "cheaper" than Citigroup.

Companies/Assets Involved

• Citigroup: Classified as a "value stock" by Morningstar, but the author argues its depressed stock price stems from fundamental issues (earnings volatility, regulatory pressure) rather than a genuine value opportunity. Its P/E ratio is approximately 10x, but its growth prospects are uncertain.
• Hilton Worldwide: Classified as a "growth stock" by Morningstar, but the author argues its valuation is reasonable (P/E ratio close to the S&P 500 average) and its fundamentals are solid (growth driven by travel recovery), making it potentially more investable than Citigroup.

Investment Implications

Investors should beware of the misleading nature of Morningstar's Value-Growth Scores framework. This classification is essentially a reverse indicator of price momentum, not a measure of fundamental value. Specific directions:

• Do not mechanically buy "value stocks" based on classification labels: For example, Citigroup's low P/E ratio may reflect a value trap rather than a margin of safety.
• Focus on the relationship between corporate fundamentals and price: Although Hilton is classified as a "growth stock," its P/E ratio is in line with the market average, and its growth certainty is high, making it potentially more worth holding than some "value stocks."
• Independently analyze the valuation logic of each company: Avoid relying on a single classification framework; instead, combine P/E, P/B, earnings trends, and industry outlook for a comprehensive judgment.