Merger and acquisition (M&A) activity has been vibrant in 2014 after experiencing a lull between 2009 and 2013. During the first seven months, the deal count was up nearly 14% year over year — by Bloomberg’s count, the 14,257 M&A deals globally so far this year have totaled $2.62 trillion, already exceeding last year’s total of $2.37 trillion. The dollar value is the largest total since 2007.1 I believe this acceleration in M&A activity offers a compelling reason for investors to consider value stocks.
What’s driving the M&A surge?
Recent M&A activity has been driven by several factors, including undervalued assets, market share gain, productivity enhancement and technology acquisition. In addition, companies have entered cross-border transactions to obtain a more favorable tax rate, a practice known as tax inversion.
M&A activity supports the value factor
Strong M&A activity appears to influence the value factor favorably. Value’s tendency to outperform growth during periods of strong M&A activity may be linked to M&A transactions putting inexpensive stocks in play for takeover. Let’s take a closer look.
By M&A deal count: The chart below shows the relationship between the volume of M&A activity and the outperformance of value stocks over growth stocks.
Increased M&A Activity Has Historically Correlated with Value Outperformance
- Since 2002, the Russell 1000 Value Index outperformed the Russell 1000 Growth Index by an average of 2.67% when the number of M&A transactions increased from the previous year. Conversely, the Russell 1000 Value Index has lagged the Russell 1000 Growth Index by an average of 4.22% when the number of M&A deals fell from the year prior.2
- The win rate — or the number of times M&A deal count rose and value outpaced growth — was 75% during that period.2
- There is a 0.72 correlation between the number of M&A announcements and the level of the Russell 1000 Value Index to Russell 1000 Growth Index price ratio spread — which means that the number of M&A announcements and the level of outperformance of the value index have historically risen and fallen together for much of the time (1.00 is perfect correlation).2
- The relationship is further supported by analysis indicating that the number of M&A announcements explains nearly 52% of the variation in the level of the Russell 1000 Value to Russell 1000 Growth price ratio spread.
By M&A dollar amount: Since 2002, the annual change in the dollar amount of M&A activity on a year- over-year basis has also influenced performance of value relative to growth. While the dollar value has been relatively stronger than the number of M&A deals, the relationship between the value factor and the dollar amount of M&A is less significant, as the chart below shows.
Dollar Amount of M&A Activity Has Influenced Value Performance
- The Russell 1000 Value Index outperformed the Russell 1000 Growth Index by an average of 3.22% when the dollar amount of M&A deals rose from the year prior. The dollar amount of M&A activity this year has already exceeded that of 2013.2
- The win rate — or the number of times M&A dollar amount rose and value outpaced growth — has historically was 87.5%.
While the quantity of M&A transactions may be strong compared with last year, it’s still below the highs after the Great Recession — suggesting that M&A activity is far from overheating and there’s potential for further activity. A continuation of recent trends would be positive for the value factor, in my view.
Learn more about PowerShares Dynamic Large Cap Value Portfolio (PWV), which offers exposure to the value factor.
1 Source: Bloomberg L.P., as of Aug. 21, 2014
2 Source: Bloomberg L.P. and Invesco PowerShares, as of Aug. 21, 2014
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This articles was written by Invesco PowerShares Senior Equity Product Strategist Nick Kalivas.