A quick google search on the topic of value investing returns countless results questioning the efficacy of value investing over the past decade. “The Death of Value Investing”, “The Case Against Value”, “Why Value Investors Fail”, “Is Value Gone for Good?”. The list goes on, and the criticism is relentless. Value investing has now underperformed growth investing for 13 years, and the difference has been significant. Over the course of the past decade, growth stocks have trounced their value stock brethren with the S&P 500 growth benchmark rising over 150% while the Russell 3000 Value Index has climbed a comparatively meager 80%.1 Even in down markets such as this year, the S&P 500 is down only 8% as compared to a much uglier negative 20% for the Russell 3000 Value index.2 With value’s last significant period of extended outperformance ending over 13 years ago, a topic that has been emerging with more frequency and fervency has been the death of value investing and the prospect of it never re-emerging as a viable and sustainable method of investing ever again.
Value investing is often considered the predecessor of all other investment styles, having materialized after the Great Depression as a more conservative and rational approach to investing. Benjamin Graham, the father of value investing, once characterized his preferred method of investing as an intelligent form of investing where the investor is a realist who sells to optimists and buys from pessimists. Inherent in such a philosophy is the idea of buying when something is undervalued and selling when something is overvalued based on overreactions to different market variables such as good news and bad news. Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value, or in simpler terms, less than what they are worth. Historically, buying stocks when they were undervalued and cheaper was always among the most intelligent and successful of investment strategies. It worked. But in the past 13 years, value investing as a discipline has failed to deliver the returns of growth investing. Something has changed.
Some of the discrepancy between value and growth performance can be attributed to differences in the underlying industry weightings comprising each index. The Russell 1000 Value Index has only a 5.9% weighting to information technology, compared with a 37.3% weighting in the growth index.3 Large-cap technology stocks such as Amazon, Apple, Facebook, Google and Microsoft have been among the best performing stocks since the 2009 financial crisis lows. Similarly, financial and energy stocks account for 20% and 7%, respectively, of the Russell 1000 Value Index. Many financial stocks have never fully recovered past valuations due to a protracted low interest rate environment and tighter regulations while the energy industry collectively struggles with profitability due to excessive supply relative to global demand in a new era with the US positioned as a net exporter of oil for the first time in history. These sectors have been a drag on performance over the current economic backdrops. Accordingly, financial stocks account for 3% and energy stocks just 0.4% of the Russell 1000 Growth Index.4
There are other factors as well. For one, the tremendous run up in equities prior to the most recent sell off in March left the market with a much smaller sample size of value stocks. As valuations have increased broadly across the equity markets in the past 13 years, many companies that started out as value companies have migrated toward becoming growth stocks over that time period. That increase in corporate valuations, coupled with a general trend to more companies pulling out of the public markets in favor of privatizing, has made the practice of finding good value stocks much more challenging as there are less good “value” stocks left to choose from. Also, the cyclical nature of investing in general has led to long periods of outperformance and underperformance for both growth and value disciplines. While growth has outperformed since the banking and financial crisis of 2008, value was a significant outperformer to growth the previous 8 years emerging from the bursting of the technology bubble. As the two disciplines have waxed and waned their ways through investor portfolios over the decades, value investing has historically performed better during periods of sustained economic growth and rising interest rates. Aside from the two years leading up to the coronavirus induced selloff, US economic growth had been fairly sluggish (market performance aside) and interest rates had been trending toward zero. Should either or both of these trends experience a reversal,
he creation of a financial and economic environment that is more favorable historically to value stocks becomes increasingly likely.
With the markets rallying off the lows that were created over a month ago, it might seem peculiar to see growth leading value on the way up. With valuations of companies being reduced so significantly by the selloff, the idea that value investing is not outperforming on the way up might seem only to add fuel to the fire in favor of the notion that value investing is truly dead. But important to realize is that thriving equity markets do not necessarily correlate to thriving economies. While rising markets may be a harbinger of good things to come on the horizon for the economy, there is no arguing that the economy is not in such good shape at this current moment. Value investing historically has performed best as the economy enters recovery, not necessarily as the market enters recovery. Moreover, while growth has outperformed during the recent upswing, leadership has really been concentrated in just a small group of companies. As the S&P 500 has closed within 8% of breaking even for the year, the NASDAQ (a somewhat “unofficial” index of growth stocks) is up close to 5% year to date.5 With respect to the broader S&P500 index, there remains decidedly negative market breadth with a 4:1 ratio of losers to winners.6 Even more, it’s the top 20 companies in the index that are disproportionately lifting the entire composite higher as the average gain among these companies is close to 40%.7 As such, the majority of the companies in the investing universe are still down on the year, still represented by suppressed valuations and still reflective of an potentially unrealized opportunity as broader trends emerge in corporate America as the economy looks to recover.
Regardless of preference, value and growth investing are very much intertwined disciplines in providing opportunities for capital appreciation. Dating back to the Great Depression, both value and growth have shared a nearly equal amount of time in providing leadership for the markets as far as performance goes, with value investing claiming the ever so slightest of measures of outperformance throughout this time span. The undeniable truth of the matter is that there are times where the prevailing factors and variables favor certain companies in certain industries with certain valuations, and that those factors and variables are always changing and presenting different companies in different industries with different valuations the same or similar opportunities. In other words, there are times when growth leads and there are times when value leads. To a certain extent, growth and value represent different phases of the corporate lifecycle for individual companies. Warren Buffet, long identified as a value investor, has always expressed growth as a necessary component in the calculation of value, whether that impact was favorable, negligible or detrimental. In such light, maybe it’s more a matter of how we label and identify stocks as either value or growth than anything else. Was Apple always a growth stock even during decades of anonymity, with little or no market appreciation? Or was it really a value stock prior to its incredible run up in amassing one of the largest market capitalizations in the world? Think about it-in 2008 Apple traded at $11/share with a 12 Price/Earnings multiple and earning .88c per share.8 Growth stock or not, there’s a lot of value in Apple going forward from that point.
It’s unlikely that the practice of investing in companies or even industries that are undervalued with solid fundamentals and strong growth and earnings potential will ever not make sense. While value investing has clearly been out of favor over the past 13 years, it’s very difficult to ignore the past century of investing experience and summarily dismiss the methodology as useless. It’s also somewhat difficult to believe that the discipline will never outperform again, especially considering that the general economic environment of the past 13 years is likely to change at some point in the future. But timing is a funny thing, and not an easy thing to predict as far as markets are concerned. As is so often the case, that just when everyone thinks that one area is so strong and another is so weak, that one is so invincible and the other so inept-that things change. Value is as cheap as it has ever been relative to growth, including immediately after the bursting of the tech bubble in 2000. Growth has led for as long as it has ever led, showing its sustainability and ability to provide extended leadership. Is value investing truly dead, or is it just resting? Regardless of if ever and whenever value investing returns to outperform growth investing, the same doomsdayers proclaiming the death of value investing will be the first to say that they knew it was only resting all along.