Tax Reform Could Boost Value ETFs

By some metrics, value currently looks cheap compared to its growth rival.

“Historically, the differential in return-on-equity (ROE) explains approximately 35% of the variation in growth/value relative valuations,” according to BlackRock. “Currently, the ROE on the Russell 1000 Growth Index is over 25%, versus less than 10% for the Value index. This spread of 16 percentage points is historically wide, but even that does not fully explain the value discount. If the historical relationship held, value stocks would be trading at around a 62% discount to growth, not today’s historically wide levels.”

Value stocks usually trade at lower prices relative to fundamental measures of value, like earnings and the book value of assets. On the other hand, growth-oriented stocks tend to run at higher valuations since investors expect the rapid growth in those company measures, but more are growing wary of high valuations.

“Tax cuts might provide the missing ingredient. The reason: Typically investors place a smaller discount on value when growth is faster, particularly nominal growth. In other words, a bit of inflation would help close the valuation gap between value and growth,” notes BlackRock.

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