Red Alert: Value is Value
June 4, 2020
It has been a long, tough road for value investing, with value stocks moving from cheap to cheaper versus growth stocks. While the trend has been in favour of growth investing, value stocks are normally expected to outperform growth stocks during a bear market. So far in 2020 that hasn’t happened. Value’s underperformance has accelerated. Although many reasons are put forward to explain the difference, I will focus on the data.
Measurement Matters
The standard practice to determine a value stock is by looking at the ratio of the stock price to the book value of assets (price/book). Low price/book is considered value, high is considered growth. Put simply, value stocks are long term bets that the stock prices will rise to reflect the fundamental value of the businesses, and combined with higher average dividends, will outperform growth stocks that have high current stock valuations, high expectations of future growth, and low dividends.
However, there is ongoing debate about the use of book value, given the difficulty of estimating it for some companies. To address this, I have worked with the broader methodology of the Russell 1000 Index. It covers the top 1000 companies by market capitalization in the U.S., which is 92% of all U.S. listed stocks. Based on the 1000 companies, Russell constructs the Russell 1000 Value Index and the Russell 1000 Growth Index. In addition to price/book, they look at expected growth from stock analysts’ estimates and historical sales per share.
Why Care?
Over the period 1929 to 2019, there was a whopping difference of 5.2% in the average annual return of the ten percent (decile) of U.S. stocks with the lowest price to book at 16.5% versus 11.3% for the bottom ten percent.[1] However, over the last decade, using the Russell 1000 data, value has underperformed growth by 3.4% annualized.
The Trend Is Not Value’s Friend
The chart below plots the monthly ratio of the return on the Russell 1000 Value Index versus the return on the Russell 1000 Growth Index to determine the relative performance of value[2]. When the line is going up value is outperforming growth, and when it is going down value is underperforming growth. The relative performance runs in long term trends, measured in years, with value having underperformed growth for 13 years, the longest since the data started in 1979.
Source: FTSE Russell
The Red Zone
As the chart above shows, value underperformed growth heading into the peak of the tech bubble in 2000, when the ratio hit 0.6, an all-time low. Once the bubble burst, value outperformed growth until 2007. Since then, value has been underperforming, with a further leg down this year, taking it into the rare territory highlighted in red. The Red Zone shows the few times (5% of the data) the ratio of value to growth has been as low as today. In other words, value is even more value.
Are We There Yet?
While it is always hazardous to try to time the reversal of a trend, at some point it will happen. But with value having had the longest underperformance period versus growth, and the return ratio in the Red Zone, it looks like we are getting close to when value should start outperforming growth for an extended period.
Invest Wisely,
Dave Schaffner, CFA
Principal, Wayfairer Capital Management Ltd.
[1] Aswath Damodaran, Musings on Markets, “A Viral Market Update VIII: A Crisis Test – Value vs Growth, Active vs Passive, Small Cap vs Large!”, May 13, 2020
[2] Similar results are obtained by using the ratio of IWD, the iShares Russell 1000 Value ETF, versus IWF, the iShares Russell 1000 Growth ETF, but there is less history as the ETFs were launched in May 2000.