Uncovering long-term value in a short-term market

Editor’s note: The interview took place in September 2023 and was edited for length and clarity.

Davis: I joined Hotchkis & Wiley 35 years ago directly out of Stanford business school. Before business school I had a job at RCM Capital, working for a great gentleman and mentor, Claude Rosenberg.¹ I also had internships at Cramer Rosenthal McGlynn and Fidelity Investments. I was introduced to the investment management business in my early years and fell in love with it.

McBride: I had two jobs out of undergrad—one with Fidelity, the other as a management consultant. I went back to Columbia Business School and was lucky enough to take a class with Bruce Greenwald, a renowned professor and proponent of value investing.² Value investing made sense to me, and I was lucky to end up at Hotchkis & Wiley as an investment analyst almost 22 years ago. I’ve been a co-manager for our diversified value strategy since 2009 and the firm’s CEO for a little less than two years, taking over that role from George, who is still fully active on the investment management side, but he’s now executive chairman at our firm as well. 

Davis: Benjamin Graham believed that you had to apply a consistent process to find value, and that carries through what we do today. The details have changed quite a bit, but the consistency and discipline are there.

McBride: The basic idea is we want to invest in companies that trade at a discount to what the company is worth. We have those opportunities because prices move a lot more than the value of companies, and they do so because markets are still driven by people and human emotion. Prices react a lot more to short-term news than they should.

Our focus is on valuing companies and staying anchored to that value. When things are going really well for a company, the market can get overly excited. When a company is facing a near-term challenge—it can be because of a macroeconomic cycle, something going on in its industry, or something with the company itself—the markets can get very pessimistic on that company. That's really the opportunity for us, to look for good businesses trading at attractive prices because the market’s focused on what’s going on in the short term, and we’re trying to focus on long-term value. We’re anchoring our decisions on what we think the long-term value of the business is.

McBride: We're a team-oriented place. All of our research is reviewed by one of our six sector teams. These teams are flat in hierarchy. Everybody has dual roles; they’re usually either an analyst or a portfolio manager in the firm. They may be an analyst who covers stocks in that area, but everyone on the team is acting as a peer reviewer or devil’s advocate when a new investment idea or an existing investment idea is reviewed.

They debate the merits of all investments, question the analysts’ assumptions, all to come to a conclusion on a couple of important points—what’s the valuation for that particular company, and what’s the risk? We quantify both of those. On the valuation side, we use an estimate of normal earnings power or an estimate of fair value. And on the risk side, we have a proprietary system ranking risk by business quality, balance sheet, and governance.

Then it’s up to the portfolio managers to take that output and build portfolios. The portfolio managers are embedded on these teams, so we’re part of that review process.

Davis: The stability, tenure, and specialization of our staff further help that process. On the investment side, we have 26 people, each an industry specialist by nature, with an average tenure of 18 years. We have very low turnover. Having an in-depth understanding of companies and having seen them through many different cycles is a differentiator for us.

McBride: That’s more specific to U.S. markets and I think it’s for a couple of reasons. As I said, markets get overly excited for some companies and in certain periods, and overly pessimistic in others. However, in some cases, the growth companies lived up to the hype. They were priced for growth, but they grew faster than expected.

The second reason is the part that I think is unsustainable—the (price-earnings) multiples have really expanded. The multiples are historically high for growth stocks but not for value stocks. There is a real opportunity for the patient value investor—this multiple expansion can’t continue forever. It will likely contract and we’ll go to a more historical relationship between value and growth. 

McBride: There’s no crystal ball. In the short term, we really don’t know. Our long-term decision making is guided by valuation.

Davis: Given the magnitude of today’s valuation spreads, it’s a good starting point for value investors. But you have to have the mentality of a marathon runner. It’s a very long road and you can’t lose resolve during those periods when your style is out of favor. Because of the research that we do, we have the conviction to be patient as the markets move in unpredictable ways over the short term.

Davis: Well, we had two 100-year storms within those 20 years. We had the financial crisis in 2007–2009, then the pandemic in 2020. It hasn't been easy being a value manager in those periods when the economy was under serious duress. Fortunately, we added value by staying the course. When the external environment is difficult, you need to focus internally on how you can do things better. Our team is stronger than it was 20 years ago, but still retains the original core essence of what we believe in.

McBride: There’s a lot more data in the world today than 20 years ago. You would think all this data and computing power would make the markets more efficient, but that has not been the case. The markets continue to be short-term-oriented, with wild changes in sentiment.

Davis: Some of it is driven by algorithmic trading. The algorithms create powerful volume, exacerbating short-term volatility.

McBride: The world is becoming more and more short-term-oriented, creating opportunities for long-term thinkers. 

• Valuations, economy may favor value stocks (article, issued August 2023)
• The Belgian lawyer who manages billions in international assets (article, issued October 2023)
• How experts identify small-/mid-cap growth leaders (article, issued August 2023)