Value investors are lamenting the state of the market. Problem is, high-tech growth-oriented firms have taken flight despite their lofty valuations while stodgy value stocks have been left behind.
The situation has caused many value managers to eat crow when discussing their results with clients. While value lost the relative performance race in recent years, its absolute returns have been reasonably good over the past decade.
To examine the state of the U.S. market in more detail, I turn to data compiled by Kenneth French, professor of finance at Dartmouth College. I start by tracking the market portfolio, which follows the largest 30 per cent of the country’s stocks and is weighted by market capitalization, like most indexes. The market portfolio advanced by an average of 10.9 per cent annually from the end of June, 1951, through to the end of December, 2019. (All of the returns herein are expressed in U.S. dollar terms, include dividend reinvestment, are based on monthly data, and do not include fees, taxes, or inflation.)
The market posted solid gains but two different value portfolios fared even better. Both start with the largest half of U.S. stocks and then narrow in on the 30 per cent with the best value characteristics. One portfolio tracks stocks with the lowest price-to-book-value ratios (P/B) and the other follows stocks with the lowest price-to-earnings ratios (P/E). The value portfolios are rebalanced each summer and are equally weighted.
The low-P/E portfolio climbed by an average of 15 per cent annually from the end of June, 1951, through to the end of December, 2019. The low-P/B portfolio gained an average of 13.9 per cent annually over the same period. They handily beat the market.
The long-term returns might inspire peacocking rather than crow-eating from value investors. But recent returns haven’t been as pleasant.
You can examine the performance of the value portfolios in the accompanying graph. It shows how well they fared relative to the index over rolling 10-year periods.
Value’s outperformance over
rolling 10-year periods
Average annual excess return (percentage points)
14
Low-P/E portfolio
Low-P/B portfolio
12
10
8
6
4
2
0
-2
-4
-6
1960
1970
1980
1990
2000
2010
2020
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE:
norman rothery (data via prof. kenneth french)
Value’s outperformance over
rolling 10-year periods
Average annual excess return (percentage points)
14
Low-P/E portfolio
Low-P/B portfolio
12
10
8
6
4
2
0
-2
-4
-6
1960
1970
1980
1990
2000
2010
2020
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: norman
rothery (data via prof. kenneth french)
Value’s outperformance over rolling 10-year periods
Average annual excess return (percentage points)
14
Low-P/E portfolio
Low-P/B portfolio
12
10
8
6
4
2
0
-2
-4
-6
1960
1970
1980
1990
2000
2010
2020
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: norman rothery
(data via prof. kenneth french)
For instance, the low-P/E portfolio trailed the market by an average of 1.6 percentage points a year over the 10 years through to the end of 2019. The portfolio also lagged earlier in 2019, in 2016, and during the internet bubble near the turn of the century. Otherwise it handily beat the market over the other 10-year periods.
The low-P/B portfolio performed well over the long term, but not quite as well as the low-P/E portfolio. It’s fair to say that the low-P/B approach has been subjected to a fair degree of criticism in recent years. Many analysts point out that book value does a poor job of reflecting the worth of intellectual property, which has become an important factor in recent decades. As a result, the ratio is missing some of what the modern world has to offer. On the other hand, the low-P/B portfolio might simply be in one of its periodic funks.
Trailing the market isn’t fun, but the situation is hardly dire in an absolute sense. The market gained an average of 13.6 per cent annually over the past decade. It beat the low-P/E portfolio’s 12 per cent average annual return and the low-P/B portfolio’s 11 per cent average annual return. They all posted double-digit average annual gains, which is pretty good.
As it happens, the value portfolios were profitable over all of the rolling 10-year periods in the record. The same can not be said for the market, which lost money over the 10 years through to the end of 2008.
Despite the recent rough patch, value investors should take heart and focus on the long term. The time will come when they will be able to once again fluff their feathers and strut their stuff in the performance parade.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Norman Rothery