If, however, we define value based on the price-to-earnings ratio, value reached its last all-time high in relative performance in 2013; using the price-to-book value ratio adjusted for intangibles, the last peak was in 2014; and using the price-to-sales ratio or the fundamental-weight-to-cap-weight ratio (where fundamental weight is a blend of five-year average sales, cash flows, and dividends and the most recent book value), the peak was in early 2017.
Regardless of how we define value, value investing posted the worst drawdown in its history over the years 2017–2020. Value’s pre-pandemic drawdown in the developed markets was slightly shorter than in the US market, starting in September 2009, but was even deeper at 19%. In the emerging markets, a value investing strategy continued to beat the market until late 2018.
The Covid pandemic and subsequent lockdown was the largest blow to the global economy since World War II, affecting most sectors, but hitting the capital- and labor-intensive sectors associated with value stocks the hardest. The virtual economy (frothy growth stocks) was largely unscathed. Investors’ rejection of value stocks in the pandemic environment makes sense because these companies tend to have anemic growth and thin profit margins. Very legitimate bankruptcy fears drove investors to shun these value stocks and pursue growth stocks, more aggressively even than during the tech bubble of 1999–2000.
The pandemic-driven value crash savaged value stocks around the world, in most cases piling even more losses on top of prior years’ losses. Value racked up another 21% of underperformance from January 2020 through August 2020 as a result of the Covid crisis, leading to a cumulative drawdown of 34% from the performance peak in December 2006. In the developed markets, value stocks lost an additional 18%, leading to a cumulative drawdown, matching that of the US market, at 34%.
Arnott et al. (2021) find that the relative valuation of value versus growth stocks is the key variable that explains value’s underperformance since January 2007. By definition, a portfolio of value stocks is always cheaper based on price-to-fundamentals ratios when compared to a portfolio of growth stocks, however, the relative discounts of the two portfolios vary widely over time.
Although time-varying, the average discount for US value stocks over the period July 1963–June 2021 is about 21%, or put another way, US growth stocks typically sport a price-to-book value ratio about five times that of value stocks. From January 2007 to September 2020, the relative valuation moved from the most expensive quartile (specifically, the 22nd most expensive percentile) to the cheapest percentile in history (100th percentile); this revaluation explains more than 100% of value’s underperformance through September 2020. In other words, net of this downward revaluation relative to growth, value would have beat growth by a respectable margin.