Value stocks have underperformed growth stocks for three decades, and an unpublished study is giving long-suffering value investors new reason to hold on to the belief.
Value stocks are stocks that are out of favor on Wall Street and trade at a discount to their book value, a measure of their net worth. Value stocks are the polar opposite of so-called growth stocks, which ride the wave of popularity and trade at high price-to-book multiples. Over the past century, value stocks have outperformed growth stocks (a trend known as the value effect), but with few exceptions, this has not been the case over the past 30 years.
In fact, if the only data available to test the value effect were for the past 30 years, statisticians would conclude that: teeth The value effect does not exist. This joins hundreds of other stock market patterns that existed in a given time period but not in a given sample. A 2015 study by Campbell Harvey of Duke University, Yang Rui of Texas A&M University, and Heqing Zhu of the University of Oklahoma analyzed over 300 stock market patterns from previous academic studies and concluded that “most of the purported findings in financial economics are probably false.”
The value effect was saved from this fate by an unpublished study, “Cross-Section of Stock Returns Pre-CRSP,” which began circulating in academic circles in 2021 but was significantly revised last month. The study was conducted by Guido Baltussen and Bert van Vliet of Erasmus University Rotterdam, and Pim van Vliet of Northern Trust Asset Management.
Specifically, the authors analyzed the period from 1866 to 1926 and focused on a database built from over 1,000 US stocks. Although book value data was not available for companies in this earlier period, dividend yields were available, and price-to-book ratios and dividend yields are highly correlated. This allowed the authors to test the value effect going back to 1866 and found that the value effect was even stronger in that earlier period than in later periods.
That’s why value investors shouldn’t use the experience of the past 30 years as a reason to give up on the value effect. The strong out-of-sample performance from 1866 to 1926 and the nearly equally strong performance in the period since 1926 show that “value is a perennial stock market phenomenon,” Baltussen said in an email. He added that there have been other periods comparable to the past 30 years when value lagged behind growth, so what we’ve seen recently is not unique. After those earlier periods, the value effect eventually gained momentum.
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Other factors
The study also analyzed the performance from 1866 to 1926 of other investment factors besides value that have underperformed in recent decades: the so-called size effect (small stocks outperforming large stocks) and the low-risk effect (low-risk stocks outperforming high-risk stocks). The researchers found that one of the drivers of recent underperformance passes the out-of-sample test (the low-risk effect) while the other fails (the small-cap effect).
The other factor the researchers analyzed has a more consistent track record: the momentum effect. According to the momentum effect, the best-performing stocks over the past year, on average, continue to outperform the market over the following months. As you can see from the accompanying chart, the researchers found that the momentum effect was one of the strongest of the various factors both before and after 1926.
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According to Baltussen, the reason he is wary of pursuing only momentum stock strategies is that momentum effects are “most pronounced in the stock market.” [trading] “Value stocks have the least amount of friction because they are unpopular and investors have little competition to buy them.”
Attractive value stock
Value stocks are especially cheap right now, not just because the value effect is concentrated in unpopular stocks, but also because the effect itself is unpopular. A cheap way to diversify into value stocks is to:
Vanguard Value
The exchange-traded fund (ticker: VTV) has a management fee of 0.04%.
CRSP U.S. Large Cap Value Index.
For those who wish to invest in a portfolio of individual value stocks, the attached table lists stocks recommended for purchase by at least two of the market-beating investing newsletters audited by my performance tracking firm. The table includes the 15 stocks with the lowest price-to-book ratios according to FactSet data. To take advantage of the low-risk effect that this study has found to have strong historical support, the list of stocks in the table is limited to stocks with betas less than 1.0, meaning that they tend not to move as much when stock prices rise or fall.
S&P 500
It rises or falls.
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Mark Hulbert is a regular contributor to Barron’s. His Hulbert Ratings tracks investment newsletters that pay a flat fee for audits. Contact him at email address.
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