Equities Article

Is There a Future for Value Investing?

Sep 12, 2019
3 min read
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What You Need to Know

It’s been a difficult decade for value investors. But we don’t agree with skeptics who say that value investing will never work again. The behavioral biases that drove value investing in the past are still pervasive, but they require new frames of reference for investors to exploit in a rapidly changing world. In this article, we analyse the ways that value stocks have been affected by changes to the interest-rate environment, industry concentration and asset intensity. By refining a disciplined, stock-picking approach, we believe value investors can generate alpha once again in a world of technology-driven industry disruption.

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Interest Rates
at historic lows have challenged value investors
Declining Competition
and lower asset intensity may not be as damaging as perceived
Cash-Flow Metrics
are a better indicator for value investors than traditional valuation metrics

The last few years have been frustrating for value investors. Ultralow interest rates have created big obstacles to success for investors in attractively valued stocks with riskier earnings profiles. Technological innovation has generated structural changes in market dynamics and investor preferences. Classic measures used by value investors, such as the price/book (P/B) ratio, have proved ineffective. Growth stocks have outperformed value stocks for most of the last decade.

Against this backdrop, many investors are asking whether there is a future for value investors. Perhaps the basic tenets of value investing just don’t work anymore in the new macroeconomic and market environment. Maybe investors should no longer assume that the forces that have underpinned the returns of value stocks in the past will support returns in the future. These are questions that we cannot ignore.

Yet in the past, value investing has prevailed through many cycles and changes in global markets. With this in mind, instead of drawing rash conclusions about the demise of value investing, we think it’s important to take a fresh look at the fundamentals of value today. In this article, we aim to show that behavioral biases that drove value investing in the past are still pervasive, but they require new frames of reference for investors to exploit in a rapidly changing world.

Core Principles of Value Investing

For decades, the core principles of value investing were a reliable guide to generating equity outperformance. While many volumes have been written about value, the tenets can be summed up in two core principles:

  • Uncertainty about earnings is pervasive: the normal level of company earnings is volatile because of cyclical trends and competitive dynamics
  • Investors are prone to emotional biases: human emotions cause overreaction to this uncertainty, which can be exploited by investors who have conviction in a company’s outlook

Applying these principles to a disciplined stock-picking process was a recipe for success in the past. And the P/B ratio was a good guide to finding value opportunities. That’s because the profitability of cheaper stocks based on P/B ratios typically regressed to the mean.

Since 1980, the cheapest quintile of P/B stocks (Q1) in a global developed equity universe improved profitability (as measured by return on equity, or ROE) over a five-year cycle while ROEs of expensive P/B companies (Q5) deteriorated (Display).

In the Past, Mean Reversion Was a Reliable Foundation for Value Investors

Global Stocks: Price/Book Quintiles

Return on Equity vs. Market, 1980-2019(Percent)
In the Past, Mean Reversion Was a Reliable Foundation for Value Investors

Through April 30, 2019
Past performance and current analysis do not guarantee future results.
Global stocks based on MSCI ACWI. Analysis of five-year cycles. Since 2015, year zero is 2015 and year four is 2019.
Source: Compustat, MSCI, Thomson Reuters Datastream, Worldscope and AllianceBernstein (AB)

These trends are not surprising. When profitability is low, weaker competitors often fail and management teams take actions to improve profitability, which drives the regression-to-the-mean pattern we see in the display above. And high levels of profitability decline over time because high returns on capital attract competitors seeking to earn those high returns; the added competition ultimately drives returns lower.

Why Has Mean Reversion Weakened?

But in recent years, the trend has weakened. Since 2015, the ROE improvement of Q1 stocks has been muted, while the ROE of expensive Q5 stocks has hardly declined (Display 2). Why have these performance patterns deteriorated? We think the explanations are rooted in transformational shifts to the global economy over the past decade. Since the global financial crisis (GFC), companies have operated in a world of modest macroeconomic growth, low interest rates and surplus capital, driven by historically relaxed monetary policies. And a technological revolution is disrupting many industries while creating powerful new global monopolies.

Mean Reversion Hasn’t Worked in Recent Years

Global Stocks: Price/Book Quintiles

Mean Reversion Hasn’t Worked in Recent Years

As of April 30, 2019
Past performance and current analysis do not guarantee future results.
Global stocks based on MSCI ACWI. Long-term average is from 1980 through April 30, 2019.
Source: Compustat, MSCI, Thomson Reuters Datastream, Worldscope and AllianceBernstein (AB)

At the same time, the behavioral biases that underpinned classic value investing haven’t really changed. Loss aversion still causes risk-averse investors to sell off poorly performing stocks, driving prices down lower than deserved. And anchoring makes investors underestimate the strength of the potential rebound of a stock price, when underperforming companies improve their profitability.

So, on balance, is value investing irrelevant? We don’t think so. But we do need to consider what has changed in the world—and what hasn’t—in order to refine a disciplined, stock-picking approach and to generate alpha once again in a world of technology-driven industry disruption.

Past performance, historical and current analyses, and expectations do not guarantee future results. There can be no assurance that any investment objectives will be achieved. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates.

The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.