Interview: Systematic Value Investing with Wes Gray

Episode Summary

Executive Summary: Wes Gray argues that value investing remains economically sensible despite years of underperformance because value returns come from earnings growth, dividend carry, and multiple changes. He says value may still underperform in absolute terms but can beat expensive growth relatively, emphasizes first-principles stock selection, prefers EBIT-based measures and quality filters, rejects most factor timing, and credits Alpha Architect’s success to transparency, education, authenticity, and disciplined niche positioning.

Main Topics: Why value investing still makes sense (Priority: 5/5): Gray explains that long-only value has not been a bad strategy in absolute terms; it has simply lagged expensive growth. He argues the core return drivers—earnings, yield, and valuation change—still support value over time. Relative vs. absolute performance in value (Priority: 5/5): He distinguishes between long-short value spreads and long-only value portfolios. The spread may be attractive for mean reversion, but long-only value can still be expensive in absolute terms and may only deliver relative, not spectacular, returns. COVID and the durability of factor models (Priority: 4/5): Gray says shocks like COVID do not break value if the process focuses on current earnings power and quality. Firms that lose earnings power should fall out of the value universe, while quality screens help avoid obvious traps. Factor timing skepticism (Priority: 4/5): He считает factor timing nearly impossible empirically and harmful because it sacrifices diversification. He prefers maintaining strategic exposure to value and momentum rather than trying to rotate between them. Choosing valuation and quality metrics (Priority: 5/5): Gray rejects book-to-market as a primary value measure and prefers EBIT-based metrics because they better reflect earnings power. He also argues quality filters should remove deteriorating businesses and improve the odds of surviving mean reversion. Alpha Architect’s business model and investor education (Priority: 4/5): The discussion closes on why Alpha Architect has succeeded: a clear mission, transparency, evidence-based investing, authenticity, and aggressive investor education. Gray emphasizes anti-selling complex strategies and limiting them to appropriate clients.

Key Arguments: Value underperformance is mostly relative to growth, not evidence that value is broken; long-only value still made money, just less than expensive growth. Value returns can be decomposed into three drivers: earnings growth, dividend yield, and valuation multiple changes; those drivers still exist. Long-short value spreads may be attractive when valuations are extreme, but most investors own long-only value, where absolute cheapness is less dramatic. COVID-like disruptions do not invalidate value if the process measures real earnings power and filters out firms that have lost it. Quality should be used to avoid cheap businesses with deteriorating fundamentals, not as a separate attempt to chase high-quality franchises at any price. Book-to-market is a poor proxy for earnings power in modern businesses; EBIT and cash-flow-based measures make more economic sense. Factor timing lacks robust empirical support and gives up diversification benefits, especially when combining value and momentum. Alpha Architect’s niche success comes from transparency, education, alignment, and honest communication about the risks of focused factor strategies.

Data Points: Value underperformance period: almost a decade - The hosts frame the discussion around a long period of value underperformance versus large-cap growth. Value spread: insane right now - Gray references long-short value spreads as unusually wide, making mean reversion arguments stronger. Dividend yield example: 3% vs. 1.5% - He uses an example where value stocks yield 3% and the market yields 1.5%, implying a built-in carry advantage. PE example: buy at 5x PE, sell at 10x PE - Gray describes valuation multiple expansion as a major contributor to value returns. Alternative PE example: buy at 5x PE, sell at 3x PE - He notes this is the kind of adverse rerating that would explain value underperformance. Fundraising month: best fundraising month ever in value - Gray says Alpha Architect saw record fundraising in value despite poor recent performance. Focus factor allocation advice: 5% of your book - He warns investors not to allocate too heavily to concentrated factor strategies. Firm book to market: a thousand dollars - Gray jokes that Alpha Architect’s physical assets are tiny, underscoring why book value is not a useful measure for the business. Other physical asset value: $3,000–$5,000 - He mentions the rowing machine and squat rack as part of the firm’s minimal book value assets. Value implementation horizon: 10 years at a time - He says focused factor portfolios can underperform for very long stretches, which is why education is essential.

Pivotal Quotes: "I’d like to get the value premium to go positive for one time in my life." — Wes Gray: Opening joke about his only remaining personal ambition and his long experience with value underperformance. "I want to understand what the hell I’m trying to achieve in the first place and what are the financial economics that make that so." — Wes Gray: His first-principles framework for designing investment strategies and selecting metrics. "It has to be bought, not sold." — Wes Gray: His explanation that complex factor products require informed, willing investors rather than aggressive salesmanship.

Implications: Listeners should expect value to remain a viable but volatile long-term approach, especially when grounded in earnings power and quality. For the industry, Gray’s message favors transparency, simple economic logic, and disciplined client education over marketing hype or blind factor rotation.