Value investors have borne the brunt of the stock market losses over the past year, but new research suggests that relief may be in sight.
Value investors have borne the brunt of the stock market losses over the past year, as banks, builders and retailers have seen their shares tumble. Now, new research suggests that relief may be in sight.
But firstly, what do we mean by 'value' and 'growth'?
Value shares are typically those that are lowly rated on any of several fundamental measures, such as:
price/earnings ratio (PE);
dividend yield; and,
net asset value per share.
Growth shares, in contrast, are usually expected to increase future sales and profits rapidly, and for this reason people are willing to pay more to own them, making them relatively expensive when measured by their current fundamentals.
Many shares don't fall neatly into either category, but for simplicity, this is probably the most common taxonomy in stock selection.
Value investing is a concept dear to the hearts, and wallets, of many Fools. It's based on the idea that the market mis-prices both of these categories, over-reacting to gloom and bad news (thus creating 'cheap' value shares), and over-estimating the fortunes of growth companies, leading investors to overpay for them.
Academic research is inconclusive, but in general the evidence tends to support the argument that value shares outperform growth shares. What is less clear is whether this is a genuine pricing anomaly, or just a return for taking on additional risk. Investors such as Warren Buffett clearly believe it's the former.
Whichever is better in the long run, they each have their moments in the sun, and if you have the wisdom and foresight to invest accordingly you will beat the market. Much easier said than done, of course.
Which brings me to last week’s research from Société Générale. According to their data, since 1952 there have been five instances when growth outperformed value for two successive years. And after each such instance, value subsequently outperformed growth for an average of seven years, beating it by an annualised seventeen percentage points.
This is of interest to us now, because growth beat value last year, and is beating it significantly again this year. SocGen's research implies that it will then be value's turn to shine.
The problem, as I see it, is establishing the extent to which that sort of historical data can be used to predict the future. For a start, it's based on only five observations from the past, so from a statistical point of view it's a little weak.
Also, as followers of Nassim Nicholas Taleb will point out, things that never happened before happen all the time. History is continuously being written; old patterns are broken, and new patterns are formed. The next occurrence, or otherwise, of a trend is just another point on that graph, either supporting or challenging the theory.
Even if we had only ever seen white swans, that would not preclude the existence of a black swan. In other words, the patterns of the past give us little insight into the future. Clearly, not everyone agrees.
Taleb's arguments notwithstanding, I'm inclined to think that statistical evidence is somewhat better than just taking a guess. Better still might be to consider and evaluate the factors influencing the various sectors of the market, in case it really is different this time.
“The greatest of all gifts is the power to estimate things at their true worth.”,
La Rochefoucauld (1613-80).
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