First things first; what is a ‘value’ stock:
Depending on who you ask, value stocks are essentially bargain stocks. They are companies who’s shares are trading at a low price relative to a measure of fundamental value such as ‘book equity’. Companies who have solid fundamentals but whose share price is below the level it should be based on its financial strength.
Here’s where it gets interesting:
Value stocks have historically delivered stronger returns than growth stocks, often by a considerable margin. Evidence from almost a century of market data supports the idea that value stocks—those with relatively low prices—offer greater expected returns. For example, since 1927, US value stocks have, on average, outperformed their growth counterparts by 4.1% per year.
But here’s the challenge:
Disappointing periods of time happen where value underperforms growth. For example, looking at the U.S. market, in any given year since 1926, growth has done better than value 41% of the time. In fact, when looking at ten-year returns, growth has outperformed value 22% of the time.
So why stay disciplined:
While disappointing periods emerge from time to time, the principle that lower relative prices lead to higher expected returns remains the same. Using the same numbers from above, in any given year, value has outperformed growth 59% of the time; and over ten-year periods value has done better 78% of the time. Importantly, value stocks often deliver quick bursts of higher returns, and in years where value stocks surpassed growth stocks, the average premium approached 15%. As investors, we believe it is critical to ‘stay in our seats’ to capture these types of returns when they show up.
Is this time different?
Many investors who like the “buy your swim suits in the winter” aspect of value investing have become increasingly impatient as the expected “value premium” fails to materialize in the share price. In the last couple of years, as mega-cap growth stocks like the Magnificent Seven continue to dominate the indexes, and many may feel that this is different, and the last bit of luster has come off the concept of value investing.
But this isn’t the first time that value stocks have lagged the growth sector for extended periods of time.
In the mid- to late 1990s, technology-related growth stocks soared. During that same period, although value stocks delivered solid returns, they fell far behind the performance numbers being posted by the growth sector. Let’s take a look at the comparison for the year 1999:
SOURCE: Dimensional Fund Advisors. Past performance is no guarantee of future results; indexes are not available for direct investment.
As shown in the chart, value stocks trailed growth in 1999 by the largest margin since the inception of the Russell Index, twenty years previously. The opening months of 2000 told much the same story; growth shot out of the gate, posting a 7% return in the first quarter, while value managed only 0.48%. Shareholders of value-based funds were angry; fund managers were ridiculed for ignoring the “new economy.” It seemed impossible that value investing would ever keep pace with growth.
But less than a year later, the tide had turned. From April to November 2000, value stocks outpaced the growth sector by 26.7%. From November until the following February, they outperformed by 39.7%. By the end of February 2001, value had erased growth’s lead and reflected outperformance for the previous one-, 3-, 5-, 10-, and 20-year periods.
The performance of value stocks during the Dot-com Bubble described above was not an isolated incident. This come-from-behind phenomenon can also be observed in other periods throughout market history. The bottom line is that if we go back nearly a hundred years in the markets, we see that value has outperformed growth a majority of the time, with an average premium over growth of 4.1% since 1927.
SOURCE: Dimensional Fund Advisors. Past performance is no guarantee of future results.
From a historical perspective, we might say that betting against value may not be the best long-term strategy.
What’s the takeaway for investors? One important one is that, as we say frequently, changes in the direction of stock prices are impossible to predict with better than random accuracy. Consider all those value investors in the 1990s who watched their “boring” holdings tick upward a little at a time, while growth stocks were going through the roof. And yet, over time, the value portion of the portfolio may have actually turned in the better performance. But how many were able to pinpoint beforehand the precise moment when value would begin to overtake growth? As we have seen, dramatic changes in the asset pricing landscape can happen in a relatively short period of time.
In other words, maintaining a portfolio diversified across various sectors is a wise course for most investors to follow. Remaining patient, even during periods of apparent underperformance, can be the key to capturing potentially dramatic gains when market circumstances change. Exposure to value stocks has proven, over the years, to be consistent with realizing expected long-term gains.
This also points to the wisdom of diversifying among asset groups with low correlation (prices tend to move in different directions from each other). While growth may be outperforming today, value may shine brighter tomorrow. Maintaining exposure to both asset classes allows the investor to capture gains in both sectors when conditions are favorable for each. This also has the effect of reducing volatility in the portfolio, since losses in one area may be offset or even negated by gains in another.
At Curio, we work with clients to create balanced, diversified portfolios that can weather a variety of market conditions. Rather than trying to guess the “right” sector to be in at a given time, our guidance helps investors position themselves to capture expected gains across a broad spectrum, a strategy that can lead to long-term growth in the portfolio. We believe that a balanced portfolio philosophy, coupled with patience and discipline, will generally allow investors to achieve their most important long-term goals.
What is your “investment temperament”? At Curio, we want to know your views on the markets and your position on the risk-reward continuum. Answers to questions like these help us design an approach that is geared to your unique needs and priorities.
To learn more, visit our website and read our article, “Perspectives on Football and Finance.”
