3 Reasons Why Value Stocks Could Outperform

Mar 22, 2017 | Securities

Value stocks are essentially underpriced businesses for which the market has low expectations. They trade at lower price/earnings (P/E) multiples relative to industry peers, to the market or to their own intrinsic value.

Typically, a good value strategy relies on catalysts that improve the underlying business, such as new management, debt restructuring or changes in the economic cycle.

Value stocks are the opposite of growth stocks, which rely on very fast expected growth and usually have much higher P/E multiples.

So, what makes value investing more attractive right now? A combination of 3 factors:

1. Historical overperformance

Over time, value investing has overperformed growth across all market caps. The following table shows the performances of both investment types from 1990 to 2015 in the US market.

Source: Fidelity Investments, Russell Value and Growth Indexes

Obviously, 26 years is a long time and most people don’t invest for that long. However, even if we break this into rolling 5-year periods, value still outperforms:

Source: Fidelity Investments, Russell Value and Growth Indexes

2. Recent underperformance

More recently, though, value stocks have been underperforming.

Before 2016, value stocks were consistently out of favor: from 2009 to 2015 the Russell 3000 Growth Index grew by 16% per year vs 11% per year for the Value Index.

Source: Fidelity Investments

During the dot-com bubble, growth stocks drastically outperformed, led by a small group of tech stocks with high P/E multiples. Then the situation suddenly reversed, and value outperformed over the next 10 years.

Since the financial crisis, we’ve been witnessing one of the longest growth rallies, although not as extreme as during the dot-com era.

Value investing in Australia, in particular, has been hit very hard by the new cycle, as the following Value/Growth comparison shows:

Source: Perpetual investment insights

After a brief pause in 2016, when value stocks accelerated, this year investors returned to high growth tech stocks, putting growth back in front:

Source: Wall Street Journal – 2017

More importantly, according to the Wall Street Journal, “value remains 10 percentage points cheaper than average compared with growth counterparts”.

3. Good fundamentals

With strong economic performance in the US, potentially boosted by Trump’s pro-growth policies, inflation and interest rates are expected to increase.

This is bad news for growth stocks and good news for value stocks. Higher inflation means that money today is worth more than further in the future. Growth stocks typically have lower profits today, but much higher expected profits in the future, and that’s what makes them attractive. Therefore, if higher inflation reduces the value of future income, it has a bigger negative impact on these companies. Value stocks, on the other hand, depend much less on future profits relative to current levels.

Higher interest rates have a similar effect: they reduce the value of future income relative to the present.

All up, there are some interesting signs emerging, which suggest a shift to more value oriented stocks should be considered.

However, this comes with two important caveats:

1 – Don’t forget growth altogether – Although value appears to be coming back into vogue, this doesn’t mean that there aren’t any attractive growth stocks either. In fact, we recommend that investors maintain a balanced approach to both and use this evidence to balance up underweight allocations.

2 – Stockpicking matters – Quality is hugely important when picking stocks of any type. If investors just pick cheap stocks blindly, they run the risk of buying value traps, which are low-quality stocks that just keep getting cheaper and cheaper.

If you want to learn how to invest in stocks and analyse the market to identify profitable or deadly turning points, contact United Global Capital today for a no cost, no obligation consultation on 03 8657 7640 or email info@ugc.net.au to learn about Quality, Value and Trend selection methodology.

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The information contained in this article is General in nature and has been prepared without taking into account your objectives, financial situation and needs.

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<a href="https://ugc.net.au/author/joel/" target="_self">Joel Hewish</a>

Joel Hewish

Joel is the founder and CEO of UGC. He is a licensed financial advisor with 15 years experience assisting clients grow, manage and protect their wealth.

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