One of my favorite activities in my career as a financial planner is meeting with clients for review sessions. These review meetings give us an opportunity to catch-up on their lives, review their progress towards their financial goals, and to answer financial and investment-related questions that clients may have. One question that has come up in a few of our recent conversations is why we continue to recommend tilting investment portfolios towards value equities when growth equities have outperformed value equities in recent years.
It is a valid question given that every year since 2010 growth equities have outperformed value equities. At this point it may make sense to define what we mean by value and growth equities. Value equities (stocks) are classified as stocks that currently trade below what they are intrinsically worth (i.e. a bargain, or value). Growth stocks are companies that are expected to continue to grow at above-average rates relative to the overall stock market, at least for some period of time. Given the definitions of the two types of stocks, financial professionals expect value stocks to outperform growth stocks over the long run simply because they are priced cheaper than growth stocks which tend to command high market prices for their earnings.
After ten years of underperformance, it is not unusual that some investors might ask why they should stick with value investing, even if value stocks are expected to outperform growth over time. Ten years is a long time to wait, even for the most patient of investors. For the answer to that question, we need to look at some historical data collected by some respected researchers.
A recent publication from Research Affiliates LLC, based in Newport Beach, CA, shows that investors’ patience can be handsomely rewarded for sticking with value investing strategies over long periods of time. As Figure 1 illustrates, a portfolio consisting of value companies outperforms a portfolio consisting of growth companies by a wide margin over a long time horizon. From July 1963 through December 2006, the value company portfolio outperformed the growth company portfolio by a whopping 9.6 times! Since January 2007, however, the value stock portfolio has underperformed the growth stock portfolio by 36% through September of 2019. Even after the recent correction the value stock portfolio still outperforms the growth stock portfolio by 6.1 times, despite five time periods of differing lengths where growth has outperformed value stocks.
As you can see from Figure 1, most time periods where growth stocks outperform value stocks are much shorter than the current period of outperformance. But such extended time periods aren’t uncommon. According to Savina Rizova, Head of Research at Dimensional Fund Advisors LP, value has trailed growth in 10-year time spans in the late 1930s, 1990s and starting in 2010. Moreover, value has historically underperformed growth in about 15% of total return periods.
It is interesting to note that after periods of poor returns relative to growth stocks, over the following decade value stocks tend to rebound sharply – outperforming growth stocks by an average of more than 8% annually.
As history illustrates, there are some time periods when investors have made more money buying more expensive stocks (growth) than purchasing cheaper stocks (value). But historical market data also provides plenty of evidence that shows these time periods are fleeting, and value stocks will earn higher returns than growth stocks sooner or later.
Given the ample supporting evidence that exists, now is probably not the best time to abandon value investing in favor of growth stocks. The only question is when value investing will once again outperform growth? Nobody can say for certain, but patient investors will eventually be rewarded.
To better understand the importance of value stocks in your investment portfolio, please contact the planners at Bollin Wealth Management LLC.
Sources: Reports of Value’s Death May Be Greatly Exaggerated Research Affilliates, LLC, Dimensional Fund Advisors LP, and the Wall Street Journal.