May 26, 2016

Value Stocks: A Valuable Opportunity?

You can divide stocks into a nearly limitless number of categories, based on everything from size to sector to region. But one of the most popular classifications is that of style: primarily growth and value.

Stocks that are priced lower than peers based on fundamental qualities like asset value, profit, and sales are considered value stocks. Value investors believe that these stocks trading at a discount to the market will provide long-term returns as their value is realized. Because they are often older, more stable companies, value stocks are often thought to provide a margin of safety or cushion against future uncertainty. Growth stocks, on the other hand, are companies that are growing sales or profit faster than the overall market. Growth companies often reinvest profit back into the business rather than paying out dividends. Growth investors are looking to the future potential of a company, whereas value investors seek existing fundamental qualities.

Many companies exhibit qualities of both growth and value, and a number of stocks appear in both growth and value indexes. Growth and value tend to cycle in terms of which is in favor at any given time, and well-diversified portfolios generally include both growth and value strategies.

We recently took a deeper look at growth and value over long time periods, and we made some interesting observations.

Value vs Growth

Note: The Fama-French HML Value Factor is the average return on the 70th percentile book/market (the inverse of price/book) and above of large companies (the largest half of companies based on market cap) and small companies (the smallest half of companies based on market cap) minus the average return on the 30th percentile of book/market and below of large companies and small companies. Source: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

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Based on price-to-book value (a company’s stock price relative to the equity on its balance sheet), value stocks have outperformed growth stocks in nearly every ten-year investment period over the past 90 years. Three notable exceptions are: the Great Depression (1929 – 1940), the Tech Bubble (1989 – 1999), and today (2005 – 2015). This outperformance extends to international stocks as well. Perhaps most interesting is that value stocks have tended to outperform after a period when they are particularly inexpensive, as they are today.

Value vs Growth-2

Source: Morningstar

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What does this mean for investors? We expect that growth and value will continue to cycle in and out of favor, and a diversified portfolio should include both investment styles. But given recent history, investors may want to evaluate their portfolio in terms of style to determine the right proportion of value versus growth based on their objectives.