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Where’s the Value?

Robin Powell  |  June 25, 2019

IT’S INTUITIVE that, the cheaper a stock is when you buy it, the greater the expected risk-adjusted return. Indeed, academic research has shown this to be true. Eugene Fama and Kenneth French demonstrated in a 1992 academic paper how, over the long term, so-called value stocks have delivered significantly higher returns than growth stocks.

Fama and French defined value stocks as those companies with a book value—the accounting difference between corporate assets and liabilities—that was high relative to their stock market value. They defined growth stocks as those with a low book-to-market ratio.

To capture the value premium, financial advisors who pay attention to academic research often recommend including a “factor tilt” toward value stocks. Historically, it’s proven to be a good move. Patient investors with low-cost exposure to value stocks have generally managed to achieve market-beating returns.

In recent years, however, questions have been raised about the wisdom of tilting toward value. In many countries, including the U.S., the value premium has been slightly negative since 2010. In 2018, it delivered its worst annual return of the current decade. Factor Research found value stocks in the U.S. typically lost 17.7% of their value in 2018, compared to a 6.6% drop in the S&P 500. The figure for Europe was even worse, at 17.9%.

Some commentators have even suggested that the value premium is dead. One explanation they give: The publicity surrounding the value premium has generated fund flows which have effectively eliminated it.

Should investors give up on tilting to value? After all, value funds are more expensive than traditional index funds that track an entire market. They’re also prone to greater volatility.

My view: Value investing still makes sense. If you’re skeptical, here are three things to bear in mind:

1. All factor premiums experience long periods of negative returns.We shouldn’t be surprised when risk factors such as value, company size and profitability underperform from time to time. It’s part and parcel of investing. If they didn’t sometimes lag the market, they wouldn’t provide a premium at all.

2. Yes, value stocks in the U.S. have underperformed the broader market since 2010. But in other developed markets, they have fared much better. During the current decade, a globally diversified value investor shouldn’t have paid more than a small penalty.

3. The valuation spread between value and growth stocks has widened. Indeed, as a result of the relatively poor performance of value stocks over the past decade, the book-to-market spread between value and growth stocks is at about the same level it was in 1992, when Fama and French published their research. The potential for outsized returns from value stocks is greater now than it has been for some time.

But before you rush into value stocks hoping to catch an upturn, bear in mind that timing factor premiums is almost impossible to do successfully. Outperformance tends to come in random bursts, often over a period of just a few days. A 2017 study by AQR Capital Management concluded: “Our research supports the approach of sticking to a diversified portfolio of uncorrelated factors that you believe in for the long-term, instead of seeking to tactically time them.”

As Warren Buffett likes to say, successful investing has far more to do with temperament than intelligence. You can know the academic literature inside out. But if you don’t have the patience and discipline to stick with your chosen strategy through thick and thin, it won’t count for anything.

Robin Powell is an award-winning journalist. He’s a campaigner for positive change in global investing, advocating better investor education and greater transparency. Robin is the editor of The Evidence-Based Investor, which is where a version of this article first appeared. His previous article for HumbleDollar was Private Matters. Follow Robin on Twitter @RobinJPowell.

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