Value: History Is On Its Side

We talk often about the importance of good investor behavior when it comes to having a successful investment experience. The need for disciplined behavior is heightened for investors who have exposure to value stocks, which are companies who are relatively underpriced in comparison to their peers.By holding Dimensional portfolios, you have an exposure to these value stocks. The truth of the matter is, and as the graph below corroborates, it has been a testing time to be an investor with increased exposure to value stocks. In the US markets, value stocks have underperformed growth stocks in 7 of the last 10 years.

Is something broken? Are the prices getting it wrong and is it time to make a change? Nothing suggests that to be the case. When you buy a stock, you are buying a proportionate ownership of the cash flows you expect to receive at future points in time. To find the price you are willing to pay for these future cash flows in today’s dollars, you need to discount those future cash flows by some discount rate. The rate used reflects the risk taken by owning that stock and compensation you expect to receive for bearing that risk. So with all things being equal, if a stock has a lower price than its peer, it means a larger discount rate was applied to find the present value of the future cash flows and higher rate of return is expected for holding that stock. The higher the discount rate, the lower the price, the higher the expected return.

Yearly Observations of Premiums
Value minus Growth: US Markets, 1927-2019

Source: Fama/French US Growth Research Index, Fama/French US Value Research Index (USD), Dimensional Returns web

As you can see by the graph, the data backs up the notion that value stocks—those with lower relative prices—have higher expected returns. On average, they have outperformed growth stocks by 4.39% annually since 1927 in the US markets despite their recent underperformance. The Canadian and global stock market, despite having fewer years to sample from, tell the same story. While there’s no way to know where stocks are going next, it’s important to understand that we’ve been through similar periods of underperformance before experiencing a strong rebound. Hang in there.