Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 271

Why has the Value investing style struggled?

We have witnessed strong world earnings-per-share (EPS) growth since June 2016, extending the post-GFC run to nearly 10 years of expansion. Given the persistence of the economic cycle, 'Momentum' strategy performance has been exceptionally strong. A Momentum strategy seeks to invest in the continuance of an existing market trend, such as upward-rising prices.

The strength of Momentum has also driven unprecedented underperformance of 'Value'-based strategies globally for the last few years. Unlike Momentum, Value-based strategies invest in undervalued companies trading at less than their estimated intrinsic value. The following chart shows how Value has suffered relative to the market in the last five years, whereas historically it has outperformed.

 

Source: Martin Currie Australia, Factset; as at 30 June 2018. Returns in US$.

EPS growth not the problem

We had originally surmised that the main reason traditional Value indices had performed poorly was that Value stocks have not shown great earnings growth compared with 'Growth' or FANG (Facebook, Amazon, Netflix and Google's parent Alphabet) stocks. However, we were surprised to find that in the global market, since June 2016, earnings growth of Value (+14.8% p.a.) has in fact been stronger than that of Growth (+12.5% p.a.).

Source: Martin Currie Australia, Factset; as at 30 June 2018.

Is now the time for Value to recover?

The recent strong returns of Growth strategies appear to have come not from earnings growth, but from a price-to-earnings (P/E) re-rating (18.7x to 20x) versus a de-rating of Value (from 14.3x to 13.1x), as shown in the chart below. The blue Growth line has recently risen while the green Value line has fallen.

Source: Martin Currie Australia, Factset; as at 30 June 2018.

So, it looks like Value stocks have been beaten up, despite their better EPS growth. Now may be the time to look for Value opportunities.

Is the growing valuation gap all it seems?

By some measures, there is evidence of a growing valuation spread – the gap between the cheapest and average-priced stocks in the market. Wide valuation spreads have historically preceded strong performance for Value strategies.

Most traditional Value indices (such as MSCI Value) are predominantly based on relatively naïve measures such as P/E or price to book (P/B). The divergence in P/E across investment styles has caused the valuation spread based on this measure to widen significantly. Dispersions of P/B, another common indicator of valuation opportunity, have also widened notably for the Australian market.

However, a note of caution: other measures, which use current earnings/cash flow-based metrics and rely less on a mean reversion assumption, are still showing far narrower dispersions. This is well described by the valuation analysis of Empirical Research Partners on the US market which uses cash flow methods. Their analysis in the next chart shows a much lower valuation spread, and as such, less Value opportunities available in the market than shown by P/E or P/B measures.

Source: Empirical Research Partners Analysis, National Bureau of Economic Research; as at 31 May 2018.

While Empirical Research Partners has a comprehensive quantitative valuation model, we believe all these measures miss a layer of fundamental insight required to truly understand the level of opportunity.

A deeper search for value

We conduct fundamental, forward-looking risk-adjusted analysis on the broad Australian market considering cashflow, quality, growth, cyclicality, and environmental, social and governance (ESG) risks. Our ongoing analysis reveals that immediately following the GFC, these Value spreads were much wider generally and also relative to each other. This was due to greater uncertainty about world growth drivers.

However, since 2009, these spreads narrowed significantly, and in February 2017 reached their lowest post-GFC levels. It is only recently that the spread for cheapest stocks has begun to really look cheap again.

Despite the better outcomes that P/E and P/B measures indicate, and the lower opportunities shown by quant measures, our analysis suggests valuation spreads have widened, but only at the extremes.

So, if Value spreads by our measures are in fact generally still low - and only in certain pockets - is the Value approach to investing compromised? In a word, no.

We believe the combination of a collective analysis of the market environment and a multi-lensed investment process (valuation, quality, direction and sustainable dividend) means it is still possible to assess the potential reward versus risk on offer of individual stocks, broad factors and the overall market regardless of the prevailing conditions.

This type of investment approach won’t deliver the same outcomes at all points in the cycle, but it certainly has helped us to navigate the choppy conditions we have seen for Value investors over the last three years.

 

Reece Birtles is Chief Investment Officer at Martin Currie Australia, a Legg Mason affiliate. Legg Mason is a sponsor of Cuffelinks. This article is general information and does not consider the circumstances of any individual.

For more articles and papers from Legg Mason, please click here.

banner

Most viewed in recent weeks

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Comparing generations and the nine dimensions of our well-being

Using the nine dimensions of well-being used by the OECD, and dividing Australians into Baby Boomers, Generation Xers or Millennials, it is surprisingly easy to identify the winners and losers for most dimensions.

Anton in 2006 v 2022, it's deja vu (all over again)

What was bothering markets in 2006? Try the end of cheap money, bond yields rising, high energy prices and record high commodity prices feeding inflation. Who says these are 'unprecedented' times? It's 2006 v 2022.

Latest Updates

Superannuation

Superannuation: a 30+ year journey but now stop fiddling

Few people have been closer to superannuation policy over the years than Noel Whittaker, especially when he established his eponymous financial planning business. He takes us on a quick guided tour.

Survey: share your retirement experiences

All Baby Boomers are now over 55 and many are either in retirement or thinking about a transition from work. But what is retirement like? Is it the golden years or a drag? Do you have tips for making the most of it?

Interviews

Time for value as ‘promise generators’ fail to deliver

A $28 billion global manager still sees far more potential in value than growth stocks, believes energy stocks are undervalued including an Australian company, and describes the need for resilience in investing.

Superannuation

Paul Keating's long-term plans for super and imputation

Paul Keating not only designed compulsory superannuation but in the 30 years since its introduction, he has maintained the rage. Here are highlights of three articles on SG's origins and two more recent interviews.

Fixed interest

On interest rates and credit, do you feel the need for speed?

Central bank support for credit and equity markets is reversing, which has led to wider spreads and higher rates. But what does that mean and is it time to jump at higher rates or do they have some way to go?

Investment strategies

Death notices for the 60/40 portfolio are premature

Pundits have once again declared the death of the 60% stock/40% bond portfolio amid sharp declines in both stock and bond prices. Based on history, balanced portfolios are apt to prove the naysayers wrong, again.

Exchange traded products

ETFs and the eight biggest worries in index investing

Both passive investing and ETFs have withstood criticism as their popularity has grown. They have been blamed for causing bubbles, distorting the market, and concentrating share ownership. Are any of these criticisms valid?

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.