To help our clients squeeze the most they can from their investments, we use a long-term, evidence-based strategy. The core of this strategy emerged from Eugene Fama's empirical analysis of stock returns, for which he won the nobel prize in 2013.
Fama showed that nearly all of a portfolios returns are explained by three factors - market risk (the return you get from putting your money in shares vs the bank), company size and value.
Let's look at value. This is a measure of "relative price", or how expensive a company is compared to it's peers. We can measure this by comparing how much the company is worth on the share market (how much would it cost to buy all of it's shares?) vs how much it's assets are worth. What we get is a price-to-book (PB) ratio, essentially the companies market value divided by it's paper value.
Looking at the S&P 500, companies typically have PB ratios between 2-5. However, we do see extreme outliers on either side. At the end of 2021, Tesla had a PB ratio of 35(!) before the price fell significantly in the following year. On the other hand, during 2020, airlines and energy companies saw PB ratios below 1.
These companies with high PB ratios are considered growth companies, as the justification for their high prices is the expectation of high future earnings. Those with lower ratios are considered value companies, as their lower prices are indicative of a riskier investment.
The higher risk of value companies means higher expected returns for investors. When properly diversified, portfolios with a higher exposure to these companies deliver better returns.
With this being said, growth companies soared during the lead up and start of the COVID pandemic. Tech companies, which had already performed well before lockdowns, experienced continued growth. Many commentators during this time spoke of the death of value.
The previous two years saw value companies rebound. More importantly, history shows us value's long track record of successes. Below is a chart showing 45 years of annual Australian stock returns comparing value and growth.
Historically, value stocks have outperformed growth stocks in Australia, and the outperformance in a given year has often been striking.
Data covering nearly half a century backs up the notion that value stocks—those with lower relative prices—have higher expected returns.
Value premiums have often shown up quickly and in large magnitudes. For example, while the average annual value premium since 1977 has been 5.8%, in years when value outperformed growth, the average premium was over 17%.
There is no evidence investors can reliably predict when value premiums will show up. Rather, a consistent focus on value stocks is essential to capturing these outsize value premiums when they do appear.
Logic and history support a commitment to value stocks so investors can be positioned to take part when those shares outperform in the future.
A focus on long-term drivers of returns is essential to our investing strategy. There may be short periods where value lags growth, small companies lag large companies, or even when shares underperform cash in the bank.
The research supporting these factors is incredibly thorough and robust. Long-term, this strategy is proven to deliver better returns for investors.