We are pleased to share Dimensional Fund Advisors' recent update on value investing. As a reminder, value stocks are those trading at low prices relative to measures of fundamental value (such as cash flow, earnings, book equity), and growth stocks are those trading at high prices relative to the same measures.
Rappaport Reiches Capital Management utilizes Dimensional's Core funds for our clients' stock portfolios. The Core funds look to closely track the overall market's performance through broad diversification, and own both growth and value stocks. While growth stocks, driven by large tech companies such as Apple, Amazon and Microsoft, have outperformed over the last few years, value stocks remain an important component of a diversified portfolio.
The Core portfolios have modest additional exposure towards value stocks relative to traditional index funds. Dimensional's research piece below discusses the rationale behind this additional exposure.
Logic and Data Provide the Basis for a Positive Expected Value Premium
Dimensional Fund Advisors, July 2020
There is pervasive historical evidence of value stocks outperforming growth stocks. Data covering nearly a century in the US, and nearly five decades of market data outside the US, support the notion that value stocks—those with lower relative prices—have higher expected returns.
Recently, growth stocks have enjoyed a run of outperformance vs. their value counterparts. But while disappointing periods emerge from time to time, the principle that lower relative prices lead to higher expected returns remains the same. On average, value stocks have outperformed growth stocks by 4.54% annually in the US since 1928, as Exhibit 1 shows.
Exhibit 1:Yearly observation of premiums (value minus growth in US markets, 1928 - 2019)
In US dollars. Yearly premiums are calculated as the difference in one-year returns between the two indices described. Value minus growth: Fama/French US Value Research Index minus the Fama/French US Growth Research Index. Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
Some historical context is helpful in providing perspective for growth stocks’ recent outperformance. As Exhibit 1 demonstrates, realized premiums are highly volatile. While periods of underperformance are disappointing, they are also within the range of possible outcomes.
We believe investors are best served by making decisions based on sound economic principles supported by a preponderance of evidence. Value investing is based on the premise that paying less for a set of future cash flows is associated with a higher expected return. That’s one of the most fundamental tenets of investing. Combined with the long series of empirical data on the value premium, our research shows that value investing continues to be a reliable way for investors to increase expected returns going forward.
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