Value Stocks Are Only A Value Until They’re Not

Value Stocks Are Only A Value Until They’re Not
Paul Allison, CFA

about 1 year ago2 mins

The value investing style, which aims to buy shares that appear cheap on measures like price-to-earnings or price-to-book, had been getting trounced for much of the past decade by the growth style, which aims to buy companies that appear expensive on those measures but that have sparkling futures with lots of potential profit. But this year, value’s been striking back.

The chart shows the price of the Vanguard Value ETF (ticker: VTV; expense ratio: 0.04%) relative to the Vanguard Growth ETF (VUG; 0.04%). And lately, the line’s been moving higher because the value ETF’s been doing better. That makes some sense: the popular argument goes that with near-zero interest rates now a thing of the past, the winds have shifted in value’s favor. See, it was never really the case that ultra-low rates were bad for value stocks, but they did hoist up the valuation investors were prepared to assign to growth stocks.

Plus, there’s higher-than-usual inflation now, and that’s a better backdrop for value stocks too. Keep in mind that value stocks often can be found lurking in commodity sectors like mining, and oil and gas. That’s because the valuations for companies in those highly volatile industries tend to get marked down by investors. But because the prices of fossil fuels and commodities have been relatively elevated, share prices of those firms have come into favor this year.

But there’s a counter view, and it’s this: value stocks are only value stocks until they’re not – i.e. until they become expensive. And when that happens, they’re bad investments no matter what you call them.

At this point, there’s a risk that the shares of energy firms, for example, could be expensive if they don’t continue to rake in money. Inflation might be good for commodity companies right now, but unless commodity prices go even higher, those firms will run out of growth. And after all, the only way to get better-than-inflation returns is to grow profits over and above the rate of inflation. For that, growing companies are better.

Ultimately, there’s no distinction between these styles. A firm’s profit growth is one input into the valuation equation – and the idea that people deliberately buy an overpriced growth stock is a fallacy. A good investment is one where the market price set by investors underestimates a firm's future growth, and they can be found in any sector or any style bucket.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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