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Value’s Revenge

Value’s Revenge

January 27, 2022
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It’s been a long and painful stretch for value investors—those who emphasize stocks in their portfolios with the lowest-relative prices.  From 2014 through mid-2020, higher-priced growth stocks dramatically outperformed lower-priced value stocks, contrary to expectation.  But the tide certainly seems to be turning.  

Let’s take a look at the recent evidence on value’s performance, which should offer some encouragement for those who have felt like their value-tilted portfolios have been out-of-step with the market or underperforming what they deserve to earn.

Why Value?

First, let’s revisit the long-term evidence on value investing as a strategy.  After separating stocks from bonds, it is possible to divide the stock market into buckets, with the two most common and informative divisions being size and relative price.  Small stocks are distinct from large stocks, and lower-priced “value” stocks are also different from higher-priced “growth” stocks.  Small stocks have historically outperformed larger cap stocks, and value stocks have outperformed growth stocks.  We have over 90 years of index data in the US that illustrates these trends.  Data over shorter periods in international and emerging markets yields the same conclusion.

The differences in stock returns are not small.  In the large cap segment of the market, value stocks have outperformed growth stocks by almost 2% per year.  In the small cap segment, where everything is more pronounced, value stocks have outperformed growth stocks by over 5% per year.  And within the value stock slice of the market, small value stocks have outperformed large value stocks by 2.5% per year.

What Works Isn't Always Working

But value doesn’t outperform growth every single year, or even every decade.  It’s no different than our expectation for stocks to outperform bonds: It happens more often than not, but not all the time.  Dimensional Fund Advisors produces the following research that illustrates this point.  The graphic below shows that historically, stocks have outperformed bonds (Treasury Bills) during 70% of one-year periods, but 78% and 86% of rolling five- and ten-year periods.  Similarly, value stocks have outperformed growth stocks during 59% of one-year periods, 72% of five-year periods, and 81% of ten-year periods.  

The lesson? Things that “work” in investing, like emphasizing stocks over bonds and value over growth, aren’t always working; if you don’t have the fortitude to stick with your strategy during the lean times you’ll never get the returns you deserve.

Value Is Surging

Fortunately for value investors who have been able to stay the course in recent years—and I count Servo clients (including myself) in this group—we’re starting to see light at the end of the tunnel.

The chart below looks at ETFs and DFA mutual funds that target the growth and value segments of the market in US large and small cap sections, as well as international markets since value’s fortunes began to turn in late 2020.

Since October 1st, 2020, according to Morningstar:

  • The DFA US Large Value Fund (DFLVX) has outperformed IWF, the iShares Russell 1000 Growth Index, by over 25%
  • The DFA US Small Value Fund (DFSVX) has outperformed IWO, the iShares Russell 2000 Growth Index, by almost 70%
  • The DFA International Value Fund (DFIVX) has outperformed EFG, the iShares EAFE Growth Index, by about 38%

These are extraordinary value premiums in a very short stretch of time, and starting to make up for some of the value underperformance in recent years.

Making Up For Lost Time

How much has value caught up in the last 12 to 18 months since it began to outperform?  Consider this—2020 was one of the single worst years on record for value stocks compared to growth, the DFA US Small Value Fund—DFSVX—gained just 2% for the year while the Vanguard S&P 500—VFINX—a basket of large stocks with mostly high prices (growth), gained over 18%.  Now, however, after a good 2021 for small value and a much better start to 2022 than growth stocks and the S&P 500, small cap value stocks have caught all the way up!  

This result warrants repeating: Any investor who bought or held small value stocks in 2020, and who sat through one of the worst stretches in history for the asset class, has made up all of their lost ground in just over a year.  Any investor who added to small value stocks in the early months of 2020 as stocks cratered (and small value lost the most) are even further ahead.  For example, the DFA US Small Value Fund has gained 62% since March 1st 2020 (the start of the Covid collapse), the Vanguard S&P 500 Fund—VFINX—has gained 45%.  

The value of disciplined rebalancing of a diversified portfolio will never be more obvious.

There's Still Value In Value

So what does the future hold for value? No one can predict for sure, but it’s reasonable to expect similar premiums for value stocks compared to growth stocks as we’ve seen historically (see first table above).  Even with the big rebound in the last 15 months for value stocks over growth stocks, they are by no means “expensive.”  

The chart below, one of my favorites, shows that growth stocks still trade at extremely high prices relative to their fundamentals, in fact the highest ever.  Value stocks, on the other hand, are still priced very reasonably.  

Some investors get a little gun shy after a year of really good results, so I can hear a few readers thinking that maybe last year was so good for value that we’re due for a cooling off this year.  But the data doesn’t support that concern.  

Whether value beat growth or not in the past year, the following year’s result tends to be the same—about a 4% higher return for value over growth.  If you’re setting an expectation for the years ahead, this is a reasonable number to use.

There has rarely been a better time to embrace a value-investing approach to achieving your long-term goals, and now that justification includes a great recent stretch of value returns for those who need to see some “proof” before making the transition.

If you would like to chat about your investments and/or retirement plan and how value investing can fit in, click here to schedule a short call with me to talk further.

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Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.