Value Is Dead; Long Live Value!

 | Aug 09, 2017 | 11:00 AM EDT
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Once again, the rumblings are getting louder: "Value is dead." It's not the first time we've heard this, nor will it be the last. To be clear, growth stocks have been knocking the stuffing out of their cheaper counterparts. But this performance divergence is most pronounced year-to date and within large-caps -- and it is the focus of the latest round of value-bashing.

For a clear example, look no further than year-to-date returns:

Year-to-Date Returns:

Large-Cap

Russell 1000 Growth: +17.67%

Russell 1000 Value: +5.87%

Small-Cap

Russell 2000 Growth: +9.85%

Russell 2000 Value: +.06%

Microcap

Russell Microcap Growth: +6.07%

Russell Microcap Value: +.27%

Those are indeed some pretty large spreads -- enough to get the financial press to again pre-announce the death of value. However, this appears to be more of a "what have you done for me lately" story than anything else. Looking back at average annual returns for the past five years, growth still beats value in large- and small-cap, but by a much smaller margin. In microcap, value wins.

Average Annual Returns for the Past Five Years:

Large-Cap

Russell 1000 Growth: +15.37%

Russell 1000 Value: +13.52%

Small-Cap

Russell 2000 Growth: +13.96%

Russell 2000 Value: +13.14%

Microcap

Russell Microcap Growth: +12.64%

Russell Microcap Value: +14.13%

Finally, going back 10 years, we again see a fairly large divergence within large-cap names -- much less so in small-cap -- but in microcap, value still beats growth.

Average Annual Returns for the Past 10 Years:

Large-Cap

Russell 1000 Growth: +9.13%

Russell 1000 Value: +5.9%

Small-Cap

Russell 2000 Growth: +7.97%

Russell 2000 Value: +6.7%

Microcap

Russell Microcap Growth: +5.74%

Russell Microcap Value: +5.9%

Clearly, the divergence between growth and value has been driven by the performance of FANG, and FANG-like stocks, where valuations seem to matter little. We've been to this rodeo before, in a sense, during the tech bubble. Valuations mattered little then too, although I would argue that the madness was much more pronounced and broad during the tech bubble than it is now.

The FANG stocks are real businesses with real products, sales and profits. Although their valuations look out of whack to me, at least they have revenue and profits; that can't be said of many of the tech bubble companies.

That era was the last time we were told that value is dead -- that the old, standard valuation metrics were no longer relevant. In fact, the situation became so dire -- as companies with little or no revenue trounced traditional value names, that at least a couple of well-known value managers told me that they'd almost succumbed to the notion that value no longer mattered.

It was no wonder that the value pros became skittish between Oct. 1 1998 and Mar. 1 2000: The Russell 1000 Growth Index beat the Russell 1000 Value Index by more than 36% (annualized). The divergence was even greater in the Russell 2000, where Growth beat Value by 67.5% (annualized).

That era was different in another way, as well. There were plenty of cheap companies available, but investors simply did not want to own them. An upstart tech company with no revenue, but the intention to manufacture wearable computers, was a whole lot more exciting than the established dividend payer trading at 10x forward earnings. At least it was exciting for a while, until the bubble burst, and then value did not look so bad any longer.

These days, there is simply not a great supply of cheap companies. Many have been bid up -- and valuations, in a broad sense, are not compelling. That leaves value investors on the hunt for special situations. Value beta is simply not working these days.

However, value is not dead, it is just sleeping. Sooner or later, even the FANG stocks will need to deliver on their inflated multiples. And if they can't, there will be a day of reckoning. Perhaps not what we saw in 2001, but Amazon (AMZN) can't trade at 125x forward earnings forever. At least I don't think it can. Can it?

We've gone through these cycles before -- growth trounces value, then value trounces growth. But it's all just part of the game, part of what makes all of this so much fun.

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