These were challenging times for value stocks. In the ten-year period ending March 31, 2020, the Fama / French US Value Research Index achieved an annualized return of 5.06%, well below the 13.04% achieved by the Fama / French US Growth Research Index. This performance divergence has led to a significant widening of the price-book spread between value and growth stocks in the United States, as shown in Exhibition 1.
Aggregate price-book ratios for value stocks versus growth stocks, US market, July 1926 – March 2020
The extension of this analysis to different markets and asset classes shows further indications of an expansion of the valuation ranges between value and growth. As we see in Appendix 2Spreads between large-cap stocks in the U.S., non-U.S. developed and emerging markets have widened broadly in the past decade. This also applied to small-cap stocks in the US and non-US industrialized countries, with only small caps from emerging countries opposing the spread widening trend.
Aggregated price-book relationships across markets
What do we think of the valuation ratio data? The price of a share corresponds to the value of a company’s expected future cash flows, which are discounted to the present. Low valuations can therefore result from low expectations of future cash flows, high discount rates or a mixture of both. It is not possible to properly isolate cash flow and discount effects from the data. As low valuations reflect high discount rates, expected returns will be higher in the future.
To the extent that a widening spread between value and growth is due to an increase in discount rates for value in relation to growth, this would mean a higher expected value premium. However, research from Dai (2016) 1 suggests that investors should be careful when using valuation spreads as input for decisions on asset allocation. While the regression analysis provides some evidence of a relationship between valuation spreads and subsequent value premiums, hypothetical timing strategies that switch between valuation stocks and growth stocks based on the spread in their valuations cannot consistently outperform a simple buy-and-hold value strategy.
What is the advantage for investors? Even if the valuation spreads between value and growth vary over time, the important part is that there is a spread. Investors are demanding different expected returns for all stocks, which is sometimes reflected in different valuations. It is expected that lower price securities should deliver higher expected returns compared to fundamentals. While value awards may not appear every day, year, or decade, we believe that maintaining consistent exposure to value stocks is the most robust approach to recording the value premium, regardless of current valuations.
Wei Dai, “Premium timing with valuation ratios” (white paper, Dimensional Fund Advisors, 2016).
Price-book ratio: The ratio of a company’s market value to its book value, where the market value is calculated as the price multiplied by the number of shares issued and the book value is the value of equity that is shown in a company’s balance sheet.
Value Stock: A stock that is traded at a low price relative to a measure such as book value or profit.
Value premium: The difference in yield between value stocks and growth stocks.
Growth stock: A stock that trades at a high price relative to a measure such as book value or profit.
Market capitalization: The total market value of a company’s outstanding shares, calculated as the price times the number of shares outstanding.
Discount rate: The rate of return that determines the present value of a company’s expected future cash flows.
Regression analysis: A statistical method to estimate the strength of the relationship between a variable and one or more other variables.
The information in this document is provided to the best of our knowledge and belief without guarantee and is intended only for the background information of the recipient. It does not constitute investment advice, recommendations or an offer of services or products for sale and is not intended to provide an adequate basis for an investment decision. It is the responsibility of those wishing to make a purchase to learn about and comply with all applicable laws and regulations. The unauthorized copying, reproduction, duplication or transfer of this document is strictly prohibited. Dimensional assumes no responsibility for any loss that may arise from the use of the information contained herein.
“Dimensional” refers to the dimensional separate but connected units in general and not to a specific unit. These companies are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC and Dimensional Fund Advisors Pte. Ltd. Ltd, Dimensional Japan Ltd. and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to carry out only regulated type 1 activities (trading in securities) and does not offer any wealth management services.
Eugene Fama and Ken French are members of the board of directors of the general partner of DFAL and DIL and offer consulting services. UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
Appendix 1: Source: CRSP and Compustat. The shares are sorted by the book-to-market ratio each year in June, with the book-to-market ratio for year t being calculated based on the book capital for the last year end in t-1 divided by the market capital for the December of the t-1. Value and growth are stocks with book-to-market ratios above and below the 70th and 30th percentile for NYSE stocks. Aggregated book value, calculated as a reversal of the weighted average book-to-market ratio where market capital is for the current month.
Appendix 2: Source: CRSP, Compustat and Bloomberg. Aggregated price-book value, calculated as a reversal of the weighted average market value from book to current month until today. Size definitions: shares, sorted by market capital from June. In the United States, small caps and large caps are defined in relation to the average market capitalization of the shares listed on the NYSE. In non-US markets, large cap and small cap make up the top 90% and bottom 10% of total market cap. In emerging markets, large cap and small cap make up the top 90% and bottom 10% of total market cap in each country. Definitions of value: The shares are sorted every year in June according to the book-to-market ratio, whereby the book-to-market ratio. The market for the year t is calculated using the book capital for the last year end in t-1, divided by the market capital for December of t-1. In the US, value and growth are stocks with book-to-market ratios above and below the 70th and 30th percentiles for NYSE stocks. In non-US markets, value and growth are stocks with book-to-market ratios above and below the 70th and 30th percentiles for large-cap stocks in each region (Japan, Asia Pacific excluding Japan, Canada and Europe). In emerging markets, value and growth are stocks with book-to-market ratios above and below the 70th and 30th percentiles for large-cap stocks in each country.
Note: We are not the author of this content. For the Authentic and complete version,
Check its Original Source