Is Value Investing Dead and What Does It Mean for Investors

Value investing, a strategy made famous by Warren Buffett, has been around for decades. The core idea is to buy undervalued companies with strong fundamentals and hold them for the long term.

In recent years, value investing has faced significant challenges, including a prolonged period of low interest rates, which has made it harder to find undervalued stocks. According to a study cited in the article, the value premium, which is the excess return earned by value stocks over growth stocks, has been shrinking since the 1990s.

Many investors have turned to growth stocks, which have outperformed value stocks in recent years. The article notes that the S&P 500 Growth index has outperformed the S&P 500 Value index by a significant margin since 2010. This shift has led some to question whether value investing is still a viable strategy.

Despite the challenges, value investing remains a valid approach for long-term investors. By focusing on companies with strong fundamentals and a proven track record, value investors can potentially ride out market fluctuations and achieve superior returns over time.

The value factor has delivered impressive returns over the long term, with a cumulative performance of over 10% since 1986, as shown in the chart of the enhanced value strategy.

Value returns are closely tied to changes in the value spread, which accounts for roughly 50% of the variation in value returns. This relationship is evident in the robust negative correlation observed between value returns and changes in the value spread.

A high intercept of almost 10% in the regression analysis suggests a cleaner estimate of the value premium for a hypothetical long-minus-short value factor, purged of time-varying effects.

In medium-term return scenarios, the value spread's current level of 1.73 can be used to estimate expected value returns over the next 12 months. For instance, if the value spread reverts to 1.5 as of January 2020, the expected value return could be significantly higher.

I've noticed that the traditional value/growth debate is becoming less relevant due to a changing investment landscape.

Investors should consider that we may be in a new investment landscape characterized by higher inflation and rates, plus more investment and spending targeted toward enabling the energy transition.

With growth indices becoming more concentrated in mega-cap technology stocks, many investors should seek to improve overall portfolio diversification with increased allocations to value.

This shift in investment landscape may require investors to rethink their traditional asset allocation strategies.

Investors should be aware that growth indices are becoming increasingly concentrated, which can lead to higher risk and lower returns.

The value factor has delivered attractive long-term returns despite the challenging period between 2018 and 2020.

The enhanced value strategy, as shown in Figure 1, has consistently outperformed the growth index since 1986, with a cumulative return of over 10%.

The value premium is not dead, as some might think. In fact, the Russell 1000 Value Index returned 10.1% per year from 1992 to 2016, outperforming the Russell 1000 Growth Index by 1.9 percentage points.

Despite the recent recovery, value is still trading at a considerable discount compared to its 2018 levels. The valuation spread for value is still wider than it was at the beginning of the value year-end in 2018.

The relationship between value returns and changes in value spreads is robust, with the latter accounting for roughly 50% of the variation in the former. This is shown in Figure 4, which plots the continuously compounded annual value returns against annual changes in the log value spread.

A high intercept of almost 10% can be interpreted as a cleaner estimate of the value premium for a hypothetical long-minus-short value factor, given that it is purged of the time-varying effects of multiple expansions and compressions.

The current value spread of 1.73 is wider than it was at the beginning of the value year-end in 2018, and it's still about as wide as it was at the peak of the dot-com bubble in 2000.

The expected value return over the next 12 months can be estimated based on the regression from the previous slide. For instance, if the value spread reverts to 1.5 as of January 2020 (pre-Covid level), the expected value return would be around 9%.

Valuation multiples have widened significantly between growth and value stocks, with growth stocks becoming relatively more expensive.

The forward price-to-earnings (P/E) ratio of the cheapest and most expensive value portfolios over time shows that value strategies performed poorly between 2018 and 2020 due to this extreme widening.

The valuation spread, which measures the difference between the top and bottom quintile portfolios of the enhanced value strategy, has only shrunk slightly over the last two years.

The current spread is still wider at the end of December 2023 than at the beginning of the value year-end in 2018, and it's about as wide as it was at the peak of the dot-com bubble in 2000.

Small-value stocks are trading at historically cheap valuations relative to their market counterparts, indicating the likelihood of a large premium going forward.

The relative valuations of Avantis US Small Cap Value ETF AVUV and Avantis International Small Cap Value ETF AVDV, along with Avantis Emerging Markets Value ETF AVES, compared with Vanguard's broad market index funds, show that the value spread is at historically high levels.

The value spread contains information about future returns, with the future value premium tending to be much higher after periods when the valuation spread is above the median spread.

The valuation spread is well above the median today, indicating that value investing may still have a place in a portfolio.

Investors should consider that the value premium may not be dead after all. The past 25 years, from 1992 to 2016, saw the Russell 1000 Growth Index return 8.2% per year, underperforming the Russell 1000 Value Index return of 10.1% per year.

The annual average value premium during this period was 4.5%, not much different from the 5.1% premium for the period 1927 through 1991. This suggests that the value premium was still present even after the publication of the Fama-French research on the value premium.

Investors can improve overall portfolio diversification by allocating more to value stocks, particularly in a new investment landscape characterized by higher inflation and rates, plus more investment and spending targeted toward enabling the energy transition.

Value investing is a strategy that focuses on buying undervalued stocks with the potential for long-term growth. The value premium, which is the excess return of value stocks over growth stocks, has been a reliable indicator of future returns.

Research has shown that the value premium is not dead, despite its recent poor performance. In fact, a 25-year period from 1992 to 2016 saw the Russell 1000 Growth Index return 8.2% per year, underperforming the Russell 1000 Value Index return of 10.1% per year.

The value spread, which measures the difference in valuations between value and growth stocks, has been a key factor in determining future returns. A study found that the value spread accounted for roughly 50% of the variation in value returns.

The current value spread is at historically high levels, indicating that value stocks are trading at a significant discount compared to growth stocks. This raises the question: Does the value spread contain information about future returns?

Historical data shows that the future value premium tends to be much higher after periods when the valuation spread is above the median spread. And today, the valuation spread is well above the median.

The enhanced value strategy has shown impressive long-term performance, with a cumulative return of over 10% per year since 1986. However, its recent performance has been poor, mainly due to an extreme widening of valuation multiples between growth and value stocks.

The valuation spread between value and growth stocks has only shrunk slightly over the last two years, and it's still wider than it was at the beginning of the value year-end in 2018. This suggests that value stocks are still undervalued compared to growth stocks.

A forward price-to-earnings (P/E) ratio of the cheapest and most expensive value portfolios over time shows that the valuation multiples have become relatively more expensive for growth stocks.

This table shows the historical relationship between the valuation spread and future returns. It's clear that the value spread contains valuable information about future returns.

Conventional value strategies often have high environmental footprints, including greenhouse gas emissions.

The conventional value factor tends to have a larger carbon footprint than non-value stocks.

According to the article, decarbonizing the value factor without significantly impacting value exposure is possible.

The article's authors demonstrate that their decarbonization methodology reduces the carbon footprint without impacting exposure to the value factor.

The investment universe for this analysis consists of all nonfinancial constituents of the MSCI Developed and Emerging Markets indices.

The sample period for this analysis is January 1986 to March 2023, and November 2020 to March 2023.

Decarbonizing the value factor effectively can help value investors avoid climate traps.