Value stocks have underperformed severely in recent years, leading many investors to question the relevance of value investing or even to contemplate its demise.
Studies have shown that prices of stocks trading at large discounts to future earnings, cash flows or book value tend to outperform peers trading at large premiums. However, this has not been seen since 2007. Instead, value stocks have been getting cheaper and expensive stocks have become dearer. The widening of the gap – the value spread – has been observed across regions and sectors.
What is going on?
By the end of 2020, value spreads had reached the extreme highs seen at the peak of the tech bubble in 2000.
We believe the resulting underperformance of value stocks comes from prices diverging from fundamental values. We do not see much room for this trend to continue.
A positive outlook for value stocks
In our view, expecting prices of all stocks to converge towards fundamental values remains a sensible investment philosophy and the likely trend in the coming years. The probability that value spreads will compress is now at its highest since the peak 20 years ago. Thus, we are optimistic not only about the likely performance of value stocks, but also about the performance of multi-factor strategies.