Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 271

Why has the Value investing style struggled?

We have witnessed strong world earnings-per-share (EPS) growth since June 2016, extending the post-GFC run to nearly 10 years of expansion. Given the persistence of the economic cycle, 'Momentum' strategy performance has been exceptionally strong. A Momentum strategy seeks to invest in the continuance of an existing market trend, such as upward-rising prices.

The strength of Momentum has also driven unprecedented underperformance of 'Value'-based strategies globally for the last few years. Unlike Momentum, Value-based strategies invest in undervalued companies trading at less than their estimated intrinsic value. The following chart shows how Value has suffered relative to the market in the last five years, whereas historically it has outperformed.

 

Source: Martin Currie Australia, Factset; as at 30 June 2018. Returns in US$.

EPS growth not the problem

We had originally surmised that the main reason traditional Value indices had performed poorly was that Value stocks have not shown great earnings growth compared with 'Growth' or FANG (Facebook, Amazon, Netflix and Google's parent Alphabet) stocks. However, we were surprised to find that in the global market, since June 2016, earnings growth of Value (+14.8% p.a.) has in fact been stronger than that of Growth (+12.5% p.a.).

Source: Martin Currie Australia, Factset; as at 30 June 2018.

Is now the time for Value to recover?

The recent strong returns of Growth strategies appear to have come not from earnings growth, but from a price-to-earnings (P/E) re-rating (18.7x to 20x) versus a de-rating of Value (from 14.3x to 13.1x), as shown in the chart below. The blue Growth line has recently risen while the green Value line has fallen.

Source: Martin Currie Australia, Factset; as at 30 June 2018.

So, it looks like Value stocks have been beaten up, despite their better EPS growth. Now may be the time to look for Value opportunities.

Is the growing valuation gap all it seems?

By some measures, there is evidence of a growing valuation spread – the gap between the cheapest and average-priced stocks in the market. Wide valuation spreads have historically preceded strong performance for Value strategies.

Most traditional Value indices (such as MSCI Value) are predominantly based on relatively naïve measures such as P/E or price to book (P/B). The divergence in P/E across investment styles has caused the valuation spread based on this measure to widen significantly. Dispersions of P/B, another common indicator of valuation opportunity, have also widened notably for the Australian market.

However, a note of caution: other measures, which use current earnings/cash flow-based metrics and rely less on a mean reversion assumption, are still showing far narrower dispersions. This is well described by the valuation analysis of Empirical Research Partners on the US market which uses cash flow methods. Their analysis in the next chart shows a much lower valuation spread, and as such, less Value opportunities available in the market than shown by P/E or P/B measures.

Source: Empirical Research Partners Analysis, National Bureau of Economic Research; as at 31 May 2018.

While Empirical Research Partners has a comprehensive quantitative valuation model, we believe all these measures miss a layer of fundamental insight required to truly understand the level of opportunity.

A deeper search for value

We conduct fundamental, forward-looking risk-adjusted analysis on the broad Australian market considering cashflow, quality, growth, cyclicality, and environmental, social and governance (ESG) risks. Our ongoing analysis reveals that immediately following the GFC, these Value spreads were much wider generally and also relative to each other. This was due to greater uncertainty about world growth drivers.

However, since 2009, these spreads narrowed significantly, and in February 2017 reached their lowest post-GFC levels. It is only recently that the spread for cheapest stocks has begun to really look cheap again.

Despite the better outcomes that P/E and P/B measures indicate, and the lower opportunities shown by quant measures, our analysis suggests valuation spreads have widened, but only at the extremes.

So, if Value spreads by our measures are in fact generally still low - and only in certain pockets - is the Value approach to investing compromised? In a word, no.

We believe the combination of a collective analysis of the market environment and a multi-lensed investment process (valuation, quality, direction and sustainable dividend) means it is still possible to assess the potential reward versus risk on offer of individual stocks, broad factors and the overall market regardless of the prevailing conditions.

This type of investment approach won’t deliver the same outcomes at all points in the cycle, but it certainly has helped us to navigate the choppy conditions we have seen for Value investors over the last three years.

 

Reece Birtles is Chief Investment Officer at Martin Currie Australia, a Legg Mason affiliate. Legg Mason is a sponsor of Cuffelinks. This article is general information and does not consider the circumstances of any individual.

For more articles and papers from Legg Mason, please click here.

banner

Most viewed in recent weeks

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Latest Updates

Investment strategies

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Investment strategies

Don't let Trump derail your wealth creation plans

If you want to build wealth over the long-term, trying to guess the stock market's next move is generally a bad idea. In a month where this might be more tempting than ever, here is what you should focus on instead.

Economics

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Investment strategies

Will China's EV boom end in tears?

China's EV dominance is reshaping global auto markets - but with soaring tariffs, overcapacity, and rising scrutiny, the industry’s meteoric rise may face a turbulent road ahead. Can China maintain its lead - or will it stall?

Investment strategies

REITs: a haven in a Trumpian world?

Equity markets have been lashed by Trump's tariff policies, yet REITs have outperformed. Not only are they largely unaffected by tariffs, but they offer a unique combination of growth, sound fundamentals, and value.

Shares

Why Europe is back on the global investor map

European equities are surging ahead of the U.S this year, driven by strong earnings, undervaluation, and fiscal stimulus. With quality founder-led firms and a strengthening Euro, Europe may be the next global investment hotspot.

Chalmers' disingenuous budget claims

The Treasurer often touts a $207 billion improvement in Australia's financial position. A deeper look at the numbers reveals something less impressive, caused far more by commodity price surprises than policy.

Fixed interest

Duration: Friend or foe in a defensive allocation?

Duration is back. After years in the doghouse, shifting markets and higher yields are restoring its role as a reliable diversifier and income source - offering defensive strength in today’s uncertain environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.