As has been widely documented, value stocks and the related exchange traded funds are trailing growth and momentum equivalents this year. Some market observers believe the Trump Administration’s tax reform efforts could boost the fortunes of the value factor in 2018.
Value investing is a popular long-term investment strategy. Value stocks have historically outperformed growth stocks, or companies with high earnings expectations, in almost every market over the long-haul. For instance, the MSCI USA Value Index has outperformed the MSCI USA Growth Index by an annualized 81 basis points since 1974 through September 2015.
The iShares MSCI USA Value Factor ETF (CBOE: VLUE) is a popular avenue for accessing value stocks while the Vanguard Value ETF (NYSEArca: VTV) is one of the largest smart beta ETFs of any stripe. In fact, several of the largest smart beta ETFs are value funds.
VTV follows the tracks the CRSP US Large Cap Value Index and is one of the most widely followed value ETFs. CRSP includes sales/price and historical earnings/price ratio as well as 12-month forward earnings/price ratio and dividend yield to form its value indexes.
VLUE “seeks to track the performance of an index that measures the performance of U.S. large- and mid-capitalization stocks with value characteristics and relatively lower valuations, before fees and expenses,” according to iShares.
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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