The horizontal axis in the preceding figure notes the valuation of value stocks relative to growth stocks in the US, developed ex US, and emerging markets. As we would expect, value stocks are always cheaper than growth stocks, but the degree to which value stocks are cheaper varies considerably over time. The median relative valuation of value stocks to growth stocks over the period July 1968 through September 2021 is roughly 30% when measured by an average of the following four metrics: P/S, P/E, P/B, and P/D.
As of September 30, 2021, the valuations for the value factor were 16% in the US, 18% in developed ex US, and 15% in emerging markets. The vertical axis in the preceding figure notes the subsequent five-year annualized excess return that a value strategy has generated relative to a growth strategy from each starting point used in the analysis. Whereas we observe dispersion around the line of best fit, we also see a discernable pattern in which the slope of the line indicates a relationship between starting valuation and subsequent return. Lower starting valuations translate to better performance for value strategies relative to growth strategies.
Today’s heavily discounted valuations for value stocks relative to growth stocks, and the resultant expected excess return for value stocks, make us particularly wary of today’s growth-dominated cap-weighted indices. Fortunately, investors can apply ESG preferences to any investment strategy. ESG-minded investors who are concerned with growth stocks’ high valuations can simply opt for a non-cap-weighted ESG strategy.