Style Anomaly: Value versus Growth - Analyst Blog
June 23 2011 - 11:58AM
Zacks
Summer is heating up and some of the greatest baseball rivalries
are in full swing. Think Cubs v Cardinals, Red Sox v Yankees and
Dodgers v Giants. In the world of stock investing, however, the
greatest rivalry is value v growth.
One often hears how value stocks outperform growth stocks; hence
the value stock anomaly. But, does one set of stocks, on average,
really outperform the other? Which style is experiencing a current
streak? How long has the trend lasted? When is it due for a
reversal?
First, let's define value and growth. Typical methods for
defining these styles include the Earnings-to-Price (E/P) ratio and
the analyst estimated 3-5 year growth rate (EGR). I like to use E/P
instead of P/E because earnings can be negative and value
strategies denote high earnings and low price. Therefore, value is
described as either high E/P or low EGR and growth is identified as
low E/P or high EGR.
To see if a portfolio of high earnings and low price stocks is
similar to a portfolio of low estimated growth, I looked at returns
to value stocks defined as high E/P and those defined as low EGR.
The correlation of the returns to these two portfolios was 96%. As
a result, the value stock effect can be measured using either of
these classifications. The same check was conducted with each
measure creating growth stock portfolios, which resulted in a 92%
correlation. Consequently, either definition also captures the
growth stock effect. Since the correlations between these
parameters are high, let's move forward with distinguishing value
and growth by E/P.
Starting out with a universe of the 3000 most liquid stocks, I
tested a value stock portfolio (300 stocks with the highest E/P)
and a growth stock portfolio (300 stocks with the lowest E/P) from
January 2000 – May 2011. I chose 300 stocks in each portfolio to
ensure capture of the value/growth effect and to reduce the impact
of extreme returns possible in smaller portfolios.
The results over those 11+ years indicate a tendency for value
stocks to outperform growth by an average of 1.2% per month for an
annualized return of 11.1%. These results demonstrate that the
value anomaly does exist over the long term. But, there's often a
reversal that can occur fairly quickly. The market switches its
preferred style on average every three months. The growth trend
lasts on average 7.8 weeks and the value streak lasts longer at
about 13.2 weeks.
However, over the last three years, growth and value stocks have
been in a death grip with growth minimally outperforming value
stocks to the tune of 0.4% a month. This even holds true for the
last 12 months. Typically, growth stocks tend to outperform value
stocks during periods of economic uncertainty since "growth"
implies the companies are increasing their revenue and earnings
despite economic conditions. So it's no surprise that the current
trend is to favor growth stocks. As the economy begins a definitive
expansion, one might expect value stocks to regain their favored
status.
This study provides evidence of the value anomaly and
demonstrates that value outperforms growth over the long term. Yet,
remember that many reversals do occur, and they are often
determined by economic conditions.
For example, over the past three years, growth has taken a
slight lead over value. The rationale for the value anomaly's
existence over time may lie in investors overpaying for glamour
stocks with sexy stories and lofty expectations. Often it's the
more practical value stocks, which are oversold or experiencing
temporary difficulties, that provide for better returns in the end.
The value anomaly is another example of the market not being able
to properly reflect current conditions and future expectations in
current stock prices.
Here is a method for finding stocks to take advantage of the
value anomaly:
- First, create a liquid, investible set of the stocks with
the largest 5000 market values and average daily volume greater
than or equal to 100,000 shares (if there's not enough
liquidity, it'll be hard for you to trade it).
- Next, select only those with an Earnings-to-Price >
0.11 (remember, we want high earnings to price).
- Now add an additional value filter and select those with a
Price-to-Sales ratio less than 0.8 (we want stocks with a
low Price-to-Sales).
- Finally, add a further value factor selecting only those stocks
with a Price-to-Book ratio less than 0.9 (we want stocks
with a low Price-to-Book).
Here are 5 stocks for a true value play (06/15/11):
AIG American International Group, Inc.
MET MetLife, Inc.
DB Deutsche Bank AG
CSC Computer Sciences Corporation
IM Ingram Micro Inc.
The value anomaly is just one of many types of investment
anomalies. Other examples might include anomalies based on analyst
data, insider trading and earnings surprises. To explore the world
of stock investing anomalies, please visit a website dedicated to
their explanation and discussion: hema.zacks.com. You'll be glad
you did.
Disclosure: Officers, directors and/or employees of Zacks
Investment Research may own or have sold short securities and/or
hold long and/or short positions in options that are mentioned in
this material. An affiliated investment advisory firm may own or
have sold short securities and/or hold long and/or short positions
in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and
strategies are available at:
http://www.zacks.com/performance.
AMER INTL GRP (AIG): Free Stock Analysis Report
COMP SCIENCE (CSC): Free Stock Analysis Report
DEUTSCHE BK AG (DB): Free Stock Analysis Report
INGRAM MICRO (IM): Free Stock Analysis Report
METLIFE INC (MET): Free Stock Analysis Report
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