Expert knowledge combining financial science with real world applications.

Value is Cheap

December 22, 2015

Value equity investing may be the only financial anomaly that has withstood the test of time, academic research and intellectual integrity. Logically it is easy to understand, over time cheap stocks (value = low price to book, low price to earnings) should provide a higher return that expensive stocks (growth). History has proved it to be true given the following results:

yearly obs prem 

It is clear that the value premium does not show up every year – no investment concept works all the time. It is equally clear that over the long term value investing beats growth investing with the arithmetic average being 5%. Over time the advantage of investing in value stock over growth would see $1 in 1926 grow to $32 by October 2015.

Growth of Wealth

Monthly: 07/1926 - 10/2015; Default Currency: USD

growth of wealth 

Over a more “modern” but still lengthy time frame, from 1/1979 – 11/2015 the advantage of investing in value equities is stunning. It almost appears too easy. Everyone should put all their money in a value strategy, particularly one that emphasizes smaller caps.
Monthly: 01/1979 - 11/2015; Default Currency: USD

Data Series Ann Return (%) Total Return (%) Growth of $1
S&P 500 Index 11.78137 6004.33881 61.04339
Russell 1000 Value Index 12.15155 6796.74583 68.96746
Russell 1000 Growth Index 11.11793 4800.02648 49.00026
Russell 2000 Value Index 13.0311 9102.19749 92.02197
Russell 2000 Growth Index 9.76399 3016.33069 31.16331

Growth of Wealth

Monthly: 01/1979 - 11/2015; Default Currency: USD

growth of wealth2

The problem is the long term results are great but within the period there can be dramatic periods of underperformance, periods of several years where the pundits will yell “value is broken”. Few people can hold on during these broken periods to obtain the long term returns. There are periods when growth will outperform value by over 50% on a trailing 3 year return. In February 2000 growth had outperformed value by 85% over the trailing 3 years. This makes the “value” investors feel like idiots, many throw in the towel and jump on the growth bandwagon at the wrong time. One recent study demonstrated a value investor gap in which over a specific time frame value funds out performed the broad market, but time weighted returns based on the money flows into the value funds showed that the investors underperformed the broad market because they go in after value had done well and got out during underperforming period – chasing returns.

Rolling Returns Chart

06/1936 - 10/2015 ; Default Currency: USD, Rolling Span: 10 Years, Step Inteval: 1 Month

rolling returns 

The current drought or under performance by value is one of the longest in history. Looking at monthly trailing 10 year returns of value equity compared to growth equity showed that it is extremely rare that growth outperforms value. Going back to 1936 growth has only outperformed value 2.4% of the time on a trailing 10 year period. One period was during the tech boom of the late 90’s and the other is the current period. During the tech bubble it was frequently touted value was dead, Warren Buffet had lost his touch, and if you did not develop a “new paradigm’ mantra that the internet and technology was the only future you were considered out of touch.

As noted above value came back. It came back in dramatic fashion. Over the next year alone value outperformed growth by 50%.

Why has value lagged for so long and by so much? It is never quite clear. Perhaps it is investors current preference for FANGS, Facebook, Amazon, Netflix, Google (Alphabet) and Salesforce, all large cap growth stocks, a few with minimal to no GAAP earnings. Large Cap growth on the backs of these stocks have had great relative performance. It is akin to the Nifty Fifty of the 70’s and the tech bubble of late 90’s. Could it be because of the weighting of the sectors? In the Russell 3000 Value Index the 2 sectors that have lagged the most, Financials (currently 15% of the index) and Energy (currently 6% of the index) do not have outsized weights. Perhaps it is partly based on the economic cycle – late in a growth period of the economy value stocks can underperform due to t a tightening of credit. The other culprit could simply be the animal spirits that are pushing growth equities higher.

The Value/Growth relationship has proven to be mean reverting over time with value having the upper hand given a long enough time horizon. The current historic underperformance of value presents a unique opportunity to take advantage of the weakness of what has proven to be a bona fid risk premia – value stocks.

In the Strategic Core Strategy managed by Versatile Capital we tilt heavily toward 3 factors that have withstood the test of time – Value, (smaller) Size and Low Volatility. Value, sometimes called the Buffett factor, has been the most vigorous factor and is currently trading at very cheap relative values.

Overall, the Strategic Global Core portfolio provides a strategy that can serve as the foundation of every investor’s financial portfolio. It provides broad and strategic diversification along with a careful identification and management of risk exposure optimized in a way to enhance returns. The current cheapness of value equites provides a great opportunity. With our proprietary mix of ETFs, optimization across multiple factors, and personal customization to fit your tolerance for risk, we provide an intelligent core for your broader investment goals.

Investment Advisory services are offered through Versatile Capital Management, LLC, a Registered Investment Advisor.
This newsletter contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.


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