Over the past decade value has underperformed growth investing, causing some investor disdain, and some sensational headlines portend ‘value is dead’. But is this the end of value, or is there opportunity for value to outperform growth?
In the following piece, we will explain value and growth investing styles, explore recent underperformance and the current market environment, and why, we believe, there is no statistically conclusive evidence proving value investing is ‘dead.’
- Value has historically outperformed growth over the long term and over full market cycles, and been more pronounced in small cap stocks
- Value stocks are typically in economically sensitive industries and therefore may face periods of financial duress
- Value stocks are perceived as risky, allowing investors to be rewarded for bearing more risk
- Investors should avoid overconfidence that earnings growth rates will persist for growth stocks
- Value stocks can have long periods of underperformance, and such allocations should be sized appropriately within the context of broader portfolios
LEVEL SETTING: What are Value and Growth Investing Styles?
While there are many differences between value and growth investing, three ways to identify the investing styles are price-to-book and price-to-earnings ratios, differences in dividend yields, and the type of company investors select.
- Price-to-book (P/B) and price-to-earnings (P/E) Ratios
- Value stocks tend to trade lower at lower P/B and P/E ratios, whereas growth stocks tend to trade high or above average ratios
- Difference in Dividend Yields
- Value stocks typically have higher dividend yields, while growth stocks typically pay low (or no) dividends
- Type of Companies
- Value stocks are usually more mature companies that offer slower growth of earnings and sales
- Growth stocks are typically companies with higher expected growth in earnings/revenue, as companies reinvest to grow the business
- Value Premium
- Risk comes from the volatility of an asset class and the behavioral biases of investors
- Exhaustive academic research indicates value stocks bear more risk compared to growth peers
- If risk and reward are linked, value investors will demand a higher rate of return for holding value
Expected Return Profile
Predicting when value will outperform growth is difficult. Value’s most recent period of underperformance has been prolonged and near extreme levels. However, we believe, the longer an investor holds value, the higher the probability of recognizing positive results from the value allocation.
Historically, there have been more observations of value outperformance than underperformance—as well as a stronger degree of outperformance—across a range of market environments. Over 10-year periods of observation, outcomes closely resemble a normal distribution with 3% - 6% as the average return. However, of the 15 negative observations, five have been since 2015.
In the short term, value outperformance is volatile and hard for investors to predict. Value outperformance typically experiences sharp moves, such as was exhibited during the tech bubble.
A Decade of Underperformance, But Does Opportunity Await?
As discussed previously, value has underperformed growth over the past decade – which led to widespread dislike. There are many popular explanations for this relative underperformance including technological revolution, crowded trades, low interest rates, growth of private markets, and an increased popularity of “asset-lite” businesses, which traditional measures of value ignore.
Yet, most of these explanations are just narratives. Although they may initially sound logical, there is no statistically conclusive evidence proving value investing is “dead.”
- Value’s underperformance post-2007 has primarily been a result of growth stocks becoming more expensive relative to value stocks.
- Today’s value vs. growth valuation gap is currently at the 100th percentile of historical relative valuations–investors could be faced with a unique opportunity for value to outperform growth.
Value has Value
- The current extreme valuation dispersion within value has only been rivaled by that of the tech bubble.
- Wide dispersion of value in the U.S. and emerging markets is the result of price appreciation of large technology names (e.g., FAANG & BATS) and has led emerging market valuation to be at all-time lows.
- While not as extreme, the value dispersion in International markets is still attractive.
- Value is currently one of the most attractive factors in terms of market-adjusted return when compared to the profitability, size, momentum, and low beta factors
Value Works Regardless of Measurement
- Value and profitability have historically worked together across sectors and geographies
- Historically, every measure of value has added excess return relative to its growth counterparts
Underperformance is Extreme, But Not Unheard Of
- While the current drawdown for value has been the worst, and longest, there have been others.
- The Tech and Biotech bubble drawdowns were separated by a single one-month new high for large-cap HML. If combined, they would have represented a drawdown of 14.5 years and 38.1%.
Timing Value is Hard
- Value investors in the early 2000s experienced feelings similar to that of investors today.
- When observed on a trailing one-year basis, value investing appeared dead…
- Within a year, however, value was outperforming growth in every trailing period due to the tech bubble popping. Highly valued companies sold off the most, while more appropriately valued companies held up.
Where Do We Go From Here?
- While the forecasting of value outperformance can be difficult, historical context, logic, and rigorous academic research indicates that value has outperformed over long time periods
- Due to the wide dispersion between value and growth stocks, FEG believes there is strong return potential, should value come back into favor
Despite anecdotes that ‘value is dead,’ we believe that value persists in the market today. FEG has not explicitly observed any evidence that arbitrage, quantitative easing, or factor decay can explain value’s underperformance relative to growth.
However, it is hard to predict when the outperformance of value will return, and it has experienced violent swings over time. Investors should consider the risks of prolonged style headwinds when investing in value and allocations should be sized appropriately within the context of broader portfolios.
This presentation is prepared for informational purposes only. It does not address specific investment objectives, or the financial situation and the particular needs of any person who may receive this presentation.
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