Value Stocks: Ready to Grow?

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Enhancing a portfolio’s yield

We are long-term, value-oriented investors. As such, we prefer to buy inexpensive assets, securities that we find to be reasonably priced relative to the cash flow we expect in the future. Historically, value investing has outperformed growth investing over time. However, it tends to underperform during extended market cycles as valuations — especially for growth stocks — become detached from economic reality. The environment today is indicative of such an environment in large part due to massive amounts of fiscal and monetary stimulus accompanied by widespread speculative investing.1

Patience followed by rapid rewards

While underperforming can be painful, value investors tend to be rewarded by maintaining discipline and exercising patience. The following four charts illustrate the opportunity we believe lies ahead for value investors. The lines represent the actual performance of value stocks versus growth stocks across four different indexes. When the orange lines go up, value stocks are outperforming growth stocks. When the lines go down, growth is outperforming value.

Terrific companies, attractive opportunities

Today’s value stocks encompass a number of terrific companies, including Berkshire Hathaway, Johnson & Johnson, Merck, Pfizer, Novartis, GlaxoSmithKline, Procter & Gamble, Coca-Cola, PepsiCo, Intel, Siemens, Verizon, AT&T, Walt Disney, Toyota, Visa, Mastercard and JPMorgan. Many are leaders in their respective industries, have world-class management teams and offer branded products and services around the globe. They have simply fallen out of favor as price-indiscriminate buyers (such as passive investors and day traders) have bought more popular growth stocks.

Favorable conditions

Unlocking the value within value stocks could be triggered by any one or a combination of the following catalysts:

  • Strengthening economic recovery on the other side of the pandemic
  • A market pullback triggered by reduced risk-taking
  • Tailwinds turning to headwinds for Big Tech2
  • Weakening trend toward price indiscriminate buying, including passive investing and day trading
  • Increasing level of interest rates
  • Less-than-expected support from central banks going forward

It seems likely that one or more of those could very well occur during the next couple of years. So, value could soon have its day in the sun.

Key takeaways

  1. Value offers fertile ground
    The current market environment is chock full of risks, with sparse opportunities. After years of underperformance, most of which have come in the past three to five years, value stocks around the planet appear poised to outperform.

  2. Favorable forecasts
    Depending on the asset class, our Capital Market Expectations (CMEs) indicate average annualized outperformance of value versus growth by 6% to 12% over the next seven years. Additional research we’ve performed supports those expectations.

  3. Value can grow quickly
    When value has outperformed growth, it tends to do so quickly. Historically, the reversals have occurred in just 20 to 30 months. So, there may not be enough time to plant value seeds when the growing season comes. Instead, savvy investors sow early and remain patient.

  4. Better yield while waiting
    We cannot know if, when or by how much value stocks will outperform growth in the future. However, we do know that many value companies are time-tested, solid companies generating attractive dividend yields. So, we don’t mind being paid to wait.

    Endnotes

    1For a broader discussion, see our Third Quarter 2020 Insight.
    2For a broader discussion, see our Third Quarter 2019 Insight.

    Important disclosures
    Past performance is no guarantee of future performance.
    All investments can lose value. The charts and illustrations shown are for information purposes only.

    Russell 1000 Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. Russell 1000 Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. Russell 2000 Value Index measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. Russell 2000 Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.

    MSCI EAFE Value Index captures large and mid-cap securities classified as value securities by MSCI that are members of the MSCI EAFE Index. The MSCI EAFE Growth Index is a free-float weighted index. The index represents the securities classified as growth securities by MSCI that are members of the MSCI EAFE Index. The MSCI EAFE region covers Developed Market countries in Europe, Australasia and the Far East. MSCI Emerging Markets Value Index captures large and mid-cap securities exhibiting overall value style characteristics across Emerging Markets (EM) countries. The MSCI Emerging Markets Growth Net Index is a free float weighted equity index. The index represents the securities classified as growth securities by MSCI that are members of the MSCI Emerging Markets Index.