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If you’ve attended value-investing conferences over the past few years, you’ve heard a lot of middle-aged men in khaki pants and Rockports try to explain why their favourite strategy has lagged so far behind the market.

Those of us who have a fondness for value investing can feel their pain. It has been a disappointing patch, at least relatively speaking, for people who like to hunt for stock-market bargains.

The S&P 500 Value Index, an assortment of cheap U.S. equities, generated annualized returns of 12.2 per cent over the past decade. It significantly lagged the broad S&P 500 index (14.9 per cent) and trailed far behind the high-flying S&P 500 Growth Index (17 per cent).

But this discouraging picture for value lovers is finally brightening. Over the past year, value stocks have ignited. They are beating the broader market.

All of that has put new bounce into value hunters’ Rockports. It has also fed hopes that more gains are on the horizon.

The number crunchers at market analyst Research Affiliates proclaimed last September that “value stocks stand out as the only asset class likely to generate a 5 per cent to 10 per cent real return over the coming decade.” Just this week, the US$24-billion Eureka hedge fund managed by billionaire investor Paul Marshall announced it was joining the great rotation into value by loading up on U.S. bank stocks in particular.

So is it time to put on your best khakis and join the value club?

Yes, so long as you keep your expectations in check and apply a value approach where it is likely to be most effective.

If that sounds less gushing than many of the current raves about value, so be it. The past few years – and for that matter, the past three decades – demonstrate that traditional value investing has issues.

One is value investors’ narrow definition of what constitutes a good deal. They typically look for stocks that are cheap relative to accounting fundamentals such as earnings, sales and book value. They argue this stingy approach makes sense because markets habitually underestimate the potential of unglamorous, underperforming businesses.

Maybe so, but value investors’ refusal to pay up for higher quality businesses means they miss out on growth companies that aren’t cheap but keep on growing rapidly, year after year. Many of the great businesses of the past generation – Google, Facebook, Amazon – never got much love from value investors because they never qualified as bargains on paper.

Baruch Lev of New York University and Anup Srivastava of the University of Calgary argued in a 2019 paper that traditional value investors failed to adjust to the shift to a more knowledge-based economy after 1990. These bargain hunters didn’t realize the tremendous value of intangible intellectual property that may not appear on the balance sheet.

“Value investing has generally been unprofitable for almost 30 years, barring a brief resurrection following the dot-com bust,” the researchers wrote. They held out little hope that would change any time soon.

As you might expect, this judgment has struck many value investors as rather harsh. The team at Research Affiliates argued last year that the value approach could be fixed by ditching its obsession with book value, a balance-sheet-based measure of a company’s worth. They suggested value investors should instead start adjusting their numbers to reflect the value of intangible assets.

This sounds like a promising approach. However, it also raises difficulties for individual investors, who either have to possess the accounting savvy to do the adjustments themselves or find money managers who will do it for them.

If you’re not into re-engineering accounting statements, one simple reason to like value stocks at the moment is that they are unusually cheap. Cliff Asness, co-founder of quantitative investing giant AQR Capital Management, recently flaunted a chart showing value stocks around the world to be selling at some their biggest discounts to the broad market since 1990.

That is tantalizing, especially now that value stocks are showing signs of life. It’s not clear, though, how rapidly that big discount on value stocks will narrow – rewarding long-suffering investors.

Much of value stocks’ big gains over the past year have been powered by the sudden rebound in beaten-up oil and gas stocks. These gains seem unlikely to continue at their current pace, barring yet another doubling in oil prices.

Bank stocks, another favourite of value hunters, have also done well in recent months, largely because interest rates are finally headed up and higher rates are generally good for lenders’ bottom lines. But the prospect of higher rates is now baked into banks’ share prices and isn’t likely to drive big additional gains.

All of this suggests that investors may want to put money in value stocks, but restrain their expectations for quick rewards. Canadian investors, in particular, may find the market’s turn toward value to be a bit of a non-event.

The Canadian stock market is already so tilted toward big banks and big energy companies that it functions in many ways as a value investment. Unlike the U.S., where growth stocks have ruled over the past decade, the value versus growth battle has wound up as a draw in Canada. In the 10 years to Dec. 31, the iShares Canadian Value Index ETF produced an annual average return of 8.5 per cent; the iShares Canadian Growth Index ETF, 8.9 per cent.

The bottom line here? If you’re investing globally, a tilt toward value stocks is well worth considering. But if you’re sticking to Canada, a plain-vanilla index fund that tracks the entire market may be just as good a bet.

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