Ariel's John W. Rogers Jr.: Value and Small Stocks Will Lead
The new value cycle is just getting going. Celebrated value investor John Rogers gives his take on what's to come, which sectors he thinks are cheap right now and why he's cautious on crypto.
John W. Rogers Jr. is chairman, co-CEO and chief investment officer of Ariel Investments, which he founded in 1983. He is the lead manager of Ariel Fund (ARGFX) and comanager of Ariel Appreciation Fund. Read on as we ask Rogers about value, small companies and risks facing the market.
You're a celebrated value investor. How do you define value? We think of it as buying stocks that are selling at a discount to their private-market value. For us, an undervalued security is selling at more than a 40% discount to what we think the value of the company is.
Value investing struggled for a long time but came back in a big way after last year's bear market, and your funds have done very well. What accounts for value's comeback? We've been out in the wilderness for far too long. The valuation discrepancies between growth-oriented and value stocks were at historic highs, and that gap can't persist for the long term.
The second thing is that as inflation has started to come back, people understand it will cause higher interest rates. As interest rates rise, the future earnings of growth stocks become worth less and less.
Value stocks are often generating their cash in the here and now, and also are often cyclical, meaning that as the economy comes roaring back, value stocks are going to be able to generate a lot of earnings. And those earnings will be much more valuable in a higher-interest-rate environment than the earnings of growth stocks that will be coming years and years in the future.
How long does this new value cycle have to run? It's just getting going. I'd say we're in only the second inning of a nine-inning game. I think the wind will be at our backs for at least a three- to four-year horizon. Our stocks are just so, so cheap relative to the broader market right now. It'll take a long time for that gap to close.
Where can investors find value in the market today? What have you been buying recently? We have a couple of sectors we think are very cheap.
Our favorite over the past several years has been fee-generating financial services companies. Lazard (LAZ) is the largest position in Ariel Fund. Lazard gets paid for advice on mergers and acquisitions and financial transactions. It also has a large global investment management division that's extraordinarily successful and a business that helps companies through restructuring.
A second favorite of ours is KKR & Co. (KKR), one of the preeminent private-equity firms in the world.
As the economic recovery strengthens, we have some names that are primed to benefit from pent-up demand from the COVID crisis.
Our favorite there is Madison Square Garden Entertainment (MSGE). Not only does it own the world's most famous arena, it also owns the land around the arena – very valuable midtown New York real estate. We think that as inflation comes back, real estate values will come back. And of course, as the economy comes back and COVID ends, people will be back in the Garden watching concerts and games.
The company also has an exciting project in Las Vegas called the Sphere, an innovative venue with a new way of thinking about how to entertain people. The company hopes to be able to franchise it around the world. Analysts are skeptical, but we believe the Sphere is going to be terrific.
Another favorite of ours has been doing well throughout the COVID crisis but will also do well in the recovery: Mattel (MAT).
It has iconic brands we all know – Hot Wheels, Barbie, American Girl. Kids have been stuck at home, needing things to play with, and the company has learned through this period how to benefit by selling their products over the internet. The best is still to come because Mattel has all these great brands and intellectual property that can be put into movies and other exciting opportunities down the line.
Small-company stocks have had a good run. Do you think there's more to come? I do. We've been fishing in this pond of small and mid-cap value for 38 years now. Research analysts have neglected a lot of these smaller companies, especially if they are not part of the major indexes – we talk about them being "orphaned" companies. There are a lot of opportunities to find bargains in these smaller, undervalued parts of the marketplace.
One of our favorites is Kennametal (KMT), which makes metal-cutting tools. We think it'll be a beneficiary of infrastructure spending.
Small media companies have also been neglected. Our favorite is Tegna (TGNA).
It owns television stations throughout the U.S. It's dependent on advertising, so it's kind of a perfect world right now as more people are trying to promote their products as the economy comes back. At the same time, with all the controversy in our country now, advertising from political campaigns and single-issue campaigns has been an enormous tailwind for the television industry.
What risks do you see building in the market today? One of our board members is Chris Kennedy. His grandfather was Joe Kennedy, who famously said that right before the Depression when he was getting stock tips from the shoeshine boy, he knew it was time to get out of the market.
When you had that much euphoria and that much enthusiasm and everyone thought you could get rich quick, that was the time for caution.
Today, everywhere I go, people want to talk about cryptocurrencies. I haven’t seen anything like it since the internet bubble – and this might even be worse. I'd tell people right now to be careful about chasing the "hot dot" of the moment.
I would just be very cautious and remember that the best way to invest is to think long term and to invest in great businesses you can own for a long time. That’s why our logo is the turtle, and we say slow and steady wins the race. Patience wins.
What else are you worried about? Another risk is the one caused by people falling in love with the FANG stocks. As we know, Facebook (FB), Apple (AAPL), Netflix (NFLX) and Alphabet (GOOGL), Google’s parent company, have become so well known and such extraordinary winners; they’ve boomed. They also dominate the S&P 500. But they’re not going to have the same type of performance over the next 10 years that they’ve had over the past 10 years.
None of the largest companies 20 years ago are still at the top today. It’s just amazing how what seems like a true winner for the long term ultimately gets tripped up along the way. So, I worry for investors. I’d tell them, Don’t chase the FANG stocks, and be cautious around the S&P 500.
Do you expect more market turbulence, or a significant correction, between now and the end of the year? We think we'll be reminded of what happened when the internet bubble burst around the turn of the century. We believe the S&P 500 will have a very difficult time in the second half of the year, as higher interest rates make these fast-growing companies appear more expensive.
At the same time, value-oriented, smaller companies will do fine. They’re not expensive. They have more cyclicality associated with them, so they’ll benefit from this extraordinarily strong economic recovery. You’re basically going to have a tale of two cities, with large-cap growth struggling and smaller, value-oriented indexes doing exceedingly well.
One final stock goes along with a lot of the themes we talked about.
Indexes have been booming forever, and everyone believes that indexing is the wave of the future. One of our favorite companies now is Affiliated Managers Group (AMG), which takes the contrary perspective. It's a well-diversified conglomerate of money managers. We think if active management starts to outperform in this environment, people will start to pull away from indexing and come back to active managers. Affiliated Managers will benefit from that phenomenon.