A “Value” Bias in Investing

value

Broadly speaking, value investments are those that are often acquired at a discount to their fair market price and that pay dividends.  They also tend to be perceived as “steady” and less inclined to volatility relative to their more growth oriented counterparts.  Our portfolios have a mix of U.S. and International equity investments classified as growth, but are more heavily weighted to value.  Only the smallest portfolios, limited to broad market, passive index investments with roughly equal weightings of value and growth, may lack this lean to value.

 

A closer look at portfolios will confirm this preference.  In the large cap space, value investments like PowerShares Large Cap Value (ticker, PWV) and FMI International (ticker, FMIJX) generally represent a larger percentage of the overall portfolio than their growth counterparts, Schwab U.S. Large Cap Growth (ticker, SCHG) and WisdomTree Emerging Market Consumer ETF (ticker, EMCG).  Berkshire Hathaway and IBM, which were added to larger portfolios almost a year ago, are two more examples of “value” companies.  A close inspection of mid cap, small cap and emerging market investments will turn up similar evidence of higher value weightings.

 

The Case for Value

 

Statistical research shows stocks with low price-to-book-value ratios (value stocks) outperform their growth counterparts by approximately 4.8% a year.  Value stocks have also offered a partial hedge against market risk.  Since 1980, value stocks have outperformed growth stocks by an average of 1.3% per month during months when the stock market was down.  The flip side is value underperformed growth stocks by 0.4% during months when the market was up.  However, we believe this slight underperformance in rising markets is acceptable given the almost 1% outperformance in declining markets.

 

Adding to the case that value tends to outperform is the tendency of investors to overpay for growth.  Despite the existence of sophisticated analysis tools, statistical studies suggest accurate forecasting of long-term earnings growth beyond one year is difficult at best.  Outside the 12-month projection, there also seems to be little correlation between earnings growth forecasts and what companies actually earn in future years.  Overconfidence, a behavioral bias, is also at work.  Investors tend to overstate or be overconfident in the likelihood that a high flying company will be able to continue producing better than expected earnings.

 

Conviction to Value

 

On the surface, a conviction to value seems obvious when considering an attractive price point for purchase and a history of dividends.  Numerous other criteria must be considered before picking an investment but the final decision is made somewhat easier knowing the empirical evidence supports value outperforming growth over the long term.  Asset class allocation, and a diverse basket of investments within each, will always be core tenets of our investment style.  Complimenting this with a bias to value goes a step further in support of the belief that the historical outperformance (by value) in down markets outweighs chasing returns by overweighting growth in accelerating markets.

 

[1] Content for this investment commentary was sourced from the article, “Why Value Beats Growth: A Brief Explanation”, September 2016 edition of the American Association of Individual Investors (AAII) Journal.