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IN MARKETS AROUND THE WORLD, value stocks have underperformed growth stocks for more than a decade. For any asset allocator, the apparent result is tough to ignore: Value looks cheap and growth looks expensive (see Figures 1 and 2 in PDF available below). To some, it’s evidence that the time has come to significantly shift allocations from growth to value in anticipation of some reversion to the mean. But others ask, “Why bother?” Their argument goes: 1) value hasn’t worked, 2) we don’t see rates rising, 3) chances are low that the economic cycle will accelerate above 2019 levels, and 4) we are tired of seeing these charts each year and expecting a change in future returns to value (or, as Einstein put it in his definition of insanity, doing the same thing over and over again and expecting a different result).
As factor and manager researchers, we find that nearly every client we meet with wants to discuss the role value should play in their portfolios after such a long stretch of disappointment. Our answer is that value itself is not broken but the way it’s defined may well be. In this paper, we draw on our fundamental factor framework to assess the structural headwinds to value and how some managers are adapting; articulate the flaws in traditional valuation multiples given the evolving nature of corporate balance sheets; and propose a broader definition of value incorporating a discounted cash flow (DCF) valuation metric that, in combination with traditional multiples, may provide a more nuanced view of what’s “cheap” in today’s market environment.
Our key conclusions include the following:
- We believe there is a value premium driven by market participant behavior and that, despite all the headlines, value investing is not…
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