One of the most famous investing proverbs comes from Bernard Baruch (1870–1965) who, when asked for the secret of his stock market success, reportedly said, “Buy your straw hats in the winter time.” Baruch isn’t alone; a host of savvy investors, including people like Warren Buffett, are devoted believers in the principle of buying undervalued companies with future growth potential and holding them for the long term.
But, as with many facets of the stock market, there is no assurance that any investment—no matter how undervalued relative to its book value or earnings potential—will outperform the rest of the market during any given period of time. While it is true that over time, value stocks, including those of companies with smaller market capitalizations, have tended to outperform stocks in other categories, no one can tell precisely when the outperformance will happen. The only way to reliably capture the value premium is to commit to a long-term strategy that includes positioning your holdings to participate when value stocks make a move.
Recently, analysts at Dimensional Fund Advisors, a leader in value and small-cap investing, took a look at value stocks vs. growth stocks for the period from 1927 to November 2021. During some of these years, value stocks performed quite poorly, when compared to growth stocks. During others, value stocks drastically outperformed growth stocks. The following chart illustrates the annualized performance of value stocks vs. growth stocks, ranked not in chronological order, but from worst performance to best.
SOURCE: Dimensional Fund Advisors. Past performance is no guarantee of future results; indexes are not available for direct investment.
Though both value and growth stocks have tended to do well over time, their respective rates of return are usually different. In the years when value stocks have underperformed growth stocks by the greatest amount, an investor would have seen the value portion of the portfolio lag the growth portion by almost 50%. Discouraging, right? On the other hand, in the years when value outperformed growth the most, value stocks led growth by almost 90%.
But let’s take a closer look at both ends of the comparison spectrum. When the analysts at Dimensional Funds looked at both the worst-performing and best-performing quartiles of the value-growth matchup, they found a surprising amount of similarity in the performance characteristics.
SOURCE: Dimensional Fund Advisors. Past performance is no guarantee of future results; indexes are not available for direct investment.
An analysis of the relative performance of value vs. growth for each year following the performance shown in the first chart shows that for those years in the bottom quartile (the worst-performing years), value stocks outperformed growth by an average of 4.35%. At the other end of the spectrum, in the years following the top-performing quartile, value outperformed growth by an average of 4.74%. In other words, the spread between the worst- and best-performing years of value stocks vs. growth stocks is not that great, when viewed over time.
What are the main takeaways for investors?
- Prices are always difficult to predict, both for individual securities and for asset classes (like value vs. growth);
- Things can change dramatically in a short time frame (but we rarely know the exact timing);
- There is sound empirical evidence for the long-term outperformance of value stocks over growth stocks, but value stocks can underperform in any given period;
- A disciplined approach that features appropriate diversification and regular rebalancing is the best method for capturing long-term gains balanced with portfolio stability.
At Empyrion Wealth Management, we are committed to helping investors maintain well diversified, balanced portfolios that are positioned to capture the available dimensions of growth over time. To learn more about our approach to helping investors allow the market to work for them, click here to read our white paper, “The Informed Investor.”
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